Risk Perceptions and Valuation Techniques: Evidence from Investment Banks in the Wake of the 2008 Financial Crisis

Following the 2008 financial crisis, U.S. regulators proposed dramatic changes to the disclosure requirements of investment banks. Much is left unexplained regarding the decisions made by banks and their subsequent effects on performance and perceptions. Among others, the Financial Accounting Standard Board (FASB) changed the way annual reports disclosed the valuation techniques used to price financial instruments. In this paper, we analyze the decisions-making process of investment banks for the selection of these techniques. We do so by integrating the results of two theoretical backdrops. Firstly, we introduce how the theory of Performativity pertains to our analysis. Secondly, we propose a game that models how investment banks interact. The game has two players, each of which is a sub-group of banks. The banks compete on the base of a risk index which aggregates their risk perceptions.  Our goal is to qualitatively and quantitatively assess how risk perception is associated with intensity of use. To that purpose, we introduce two new constructs namely intensity of use and risk perception. The intensity of use is a way to capture the frequency of use of a valuation technique to price certain financial instruments. Using data from 10K reports of 14 investment banks, we find that the banks’ perception of risk is negatively correlated with the intensity of use of the valuation techniques. The data analysis is performed using not only inferential statistics but also game theory. The implications of this relationship are discussed.