Do investors pay sufficient attention to banks’ other comprehensive income?

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Unrealized gains and losses on available-for-sale securities (AFSGL) are included in Other Comprehensive Income (OCI) and directly affect shareholders’ equity but are not included in net income. We investigate whether investors incorporate the information conveyed by unrealized AFSGL in stock prices in a timely manner. We conduct our investigation on a sample of banks because unrealized AFSGL are a material component of OCI in the banking industry. First, we document an annual difference of 5% in future abnormal returns between banks in the top and bottom quintiles of past unrealized AFSGL. We find that investors are slow to react to the information about unrealized AFSGL. Second, we document that a zero-cost trading strategy that relies on public information regarding unrealized AFSGL generates a sizeable monthly alpha that ranges between 1.8% and 1.9%. Third, we document that financial analysts are slow to react to unrealized AFSGL. Finally, we show that unlike for banks, investors do not exhibit a delayed reaction to unrealized AFSGL in an industry where comprehensive income is a more prominent performance measure and that the 2011 change in the presentation format option for unrealized AFSGL did not eliminate price predictability. Taken together, our study shows that investors fail to fully incorporate information about unrealized AFSGL, which creates stock price predictability.

Author(s):

Romain Boulland    
ESSEC
France

Gerald Lobo    
University of Houston
United States

Luc Paugam    
HEC Paris
France