Does Uncertainty Matter for Loan Charge-Offs?

Posted: 17 Mar 2008 Last revised: 4 Feb 2015

See all articles by Laetitia Lepetit

Laetitia Lepetit

University of Limoges - Laboratoire d'Analyse et de Prospectives Économiques (LAPE)

Frank Strobel

University of Birmingham - Department of Economics

David Dickinson

University of Birmingham - Department of Economics

Date Written: October 4, 2011

Abstract

Using a stylized real options model, we show that discretion over the timing of charging off a non-performing loan could be economically justified when collateral values are uncertain and there is a chance of loan recovery. The implied hypothesis of an "uncertainty dependence" aspect in loan charge-offs is empirically tested and validated using a panel of European banks. A welfare-maximizing regulator might want to let banks pursue such discretionary loan charge-off behavior, with the problem of distinguishing it from alternative capital management and income smoothing objectives, while transparency-seeking accounting standards setters would presumably not.

Keywords: discretion, loan charge-off, uncertainty dependence, real option

JEL Classification: G21

Suggested Citation

Lepetit, Laetitia and Strobel, Frank and Dickinson, David, Does Uncertainty Matter for Loan Charge-Offs? (October 4, 2011). Journal of International Financial Markets, Institutions & Money, Vol. 22 (2), pp. 264-277, 2012; doi:10.1016/j.intfin.2011.09.006, Available at SSRN: https://ssrn.com/abstract=1095211 or http://dx.doi.org/10.2139/ssrn.1095211

Laetitia Lepetit (Contact Author)

University of Limoges - Laboratoire d'Analyse et de Prospectives Économiques (LAPE) ( email )

5 rue Felix Eboue
BP 3127
Limoges Cedex 1, 87031
France
+33555149213 (Phone)

HOME PAGE: http://www.unilim.fr/lape/

Frank Strobel

University of Birmingham - Department of Economics ( email )

Economics Department
Birmingham, B15 2TT
United Kingdom

HOME PAGE: http://www.economics.bham.ac.uk

David Dickinson

University of Birmingham - Department of Economics ( email )

Edgbaston, Birmingham B15 2TT
United Kingdom

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