Does uncertainty matter for loan charge-offs? |
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| Authors: | Laetitia Lepetit Frank Strobel David G Dickinson |
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| Institution: | 1. Université de Limoges, LAPE, Limoges, France;2. University of Birmingham, Department of Economics, Birmingham, UK;1. University of Nottingham, School of Economics, Sir Clive Granger Building, University Park, Nottingham NG7 2RD, UK;2. Università di Roma ‘Tor Vergata’, Dip. DEF, Via Columbia 2, I-00133 Rome, Italy;3. C.E.P.R., 90-98 Goswell Street, London EC1V 7DB, UK;4. School of Economics, The University of Edinburgh, 31 Buccleuch Place, Edinburgh EH8 9JT, UK;1. Department of Banking and Finance, Kainan University, 33857, No. 1 Kainan Rd., Luzhu Shiang, Taoyuan, Taiwan, ROC;2. Department of Finance, Lunghwa University of Science and Technology, No. 300, Sec. 1, Wanshou Rd., Guishan Shiang, Taoyuan, Taiwan, ROC;1. Department of Economics, University of Exeter, Rennes Drive, Streatham Court, Exeter, EX4 4PU, UK;2. Department of Quantitative Economics, University Maastricht, P.O. Box 616, 6200 MD Maastricht, The Netherlands;1. Department of Economics, University of Southampton, Southampton, SO17 1BJ, United Kingdom;2. Department of Economics, Florida State University, 113 Collegiate Loop, Bellamy 288, P. O. Box 3062180, Tallahassee, FL 32306, USA;3. Department of Economics, University of Minnesota, 1925 Fourth Str. S., 4-149 Hanson Hall, Minneapolis, MN 55455, USA;1. Department of Economics, School of Social Sciences, University of Manchester, Manchester M13 9PL, United Kingdom;2. Economics, Adam Smith Business School, University of Glasgow, Glasgow, United Kingdom |
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| 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. |
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