The Hidden Message in AFS Securities of US Banks

The International Journal of Business and Finance Research, v. 8 (3) p. 59-70, 2014

12 Pages Posted: 7 May 2014

See all articles by Richard Zhe Wang

Richard Zhe Wang

Eastern Illinois University

Menghistu Sallehu

Eastern Illinois University

Multiple version iconThere are 3 versions of this paper

Date Written: 2014

Abstract

We examine US banks’ use of available-for-sale (“AFS”) securities to smooth their earnings during the most recent macroeconomic business cycle from 2001 to 2010. We contribute to the accounting literature by investigating the interaction between the macroeconomic environment and the income smoothing activities of US banks, and find four main results: First, our empirical results show evidence that US banks use AFS securities to smooth earnings. Second, we find that the realized gains and losses on AFS securities can predict the future core earnings of a bank, consistent with the signaling hypothesis of income smoothing (e.g. Barnea et al., 1975; Bartov, 1993). Third, we report evidence that US banks are more likely to smooth income when the general macroeconomic environment is favorable (“good times”) than when it is unfavorable (“bad times”). Fourth, our tests demonstrate that the signaling power of AFS securities for future core earnings tend to be higher during bad times than good times.

Keywords: Banks, Available-for-sale Securities, Signaling Theory, Income Smoothing

JEL Classification: M41, G21

Suggested Citation

Wang, Richard Zhe and Sallehu, Menghistu, The Hidden Message in AFS Securities of US Banks (2014). The International Journal of Business and Finance Research, v. 8 (3) p. 59-70, 2014, Available at SSRN: https://ssrn.com/abstract=2394770

Richard Zhe Wang (Contact Author)

Eastern Illinois University ( email )

Charleston, IL 61920-3099
United States

Menghistu Sallehu

Eastern Illinois University ( email )

Charleston, IL 61920-3099
United States

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