Disclosed Derivatives Usage, Securitization, and the Systemic Equity Risk of Banks

We show that the information on derivatives usage and securitization activities of U.S. banks as disclosed in their pre-crisis 10-K filings predicts their systemic equity risk during the financial crisis. Investors predominantly exited stocks of banks that had previously disclosed a more extensive use of financial derivatives and loan securitization. Our findings are consistent with the hypothesis that derivatives usage for non-hedging purposes increases both firm and systemic risk. Moreover, banks which disclosed significant securitization activities and were thus potentially exposed to under-capitalized risks from conduits possess a higher vulnerability of their equity to market downturns