We provide evidence on the effects of SFAS 133 on the risk relevance of accounting measures of bank derivative exposures to bond markets. First, we find that interest rate derivatives classified as hedging are more negatively associated with fixed-rate bond spreads after SFAS 133. We also find that hedging derivatives offset non-trading positions to a greater extent after SFAS 133. Second, for the largest 25 banks, we find that interest and foreign exchange rate trading derivatives are more negatively associated with fixed-rate bond spreads after SFAS 133, consistent with more economic hedges being classified as trading after SFAS 133. For these banks, trading derivative exposures offset non-derivative trading exposures to a greater extent after SFAS 133. Our results suggest that, contrary to critics’ claims, SFAS 133 has increased the risk relevance of accounting measures of derivative exposures to bond investors and benefited banks in terms of reducing their cost of capital.

We provide evidence on how investor valuation of derivative financial instruments differs depending upon whether the fair value of these instruments is recognized or disclosed. Expanded disclosures and accounting practices prior to SFAS No. 133 and mandatory recognition of derivative fair values after SFAS No. 133 provide a natural setting for comparing the valuation implications of recognized and disclosed derivative fair value information. This unique setting mitigates many of the research design problems with recognition versus disclosure studies. Using a sample of banks that simultaneously hold recognized and disclosed derivatives prior to SFAS No. 133, we find that the valuation coefficients on recognized derivatives are significant, whereas the valuation coefficients on disclosed derivatives are not significant. Further, using a sample of banks that have only disclosed derivatives prior to SFAS No. 133, which are recognized after SFAS No.133, we find that while the valuation coefficients on disclosed derivatives are not significant, the valuation coefficients on recognized derivatives are significant. These results are consistent with the view that recognition and disclosure are not substitutes. Our findings suggest that SFAS No. 133 has increased the transparency of derivative financial instruments.