Banks' asset and liability valuation in the new regulatory environment: A game theory perspective

In the aftermath of the global financial crisis, US regulators have required banks to disclose more details regarding the valuation techniques of their traded assets and liabilities. Using data from 2013 to 2014 annual reports for nine primary dealers, we examine the determinants of the choice of the valuation techniques in a game theory setup. Consistent with their publicly disclosed shareholder policy, we assume that the banks' objective is to maximize their return on equity. Our key findings are threefold. First, we show that the optimal strategy for the global systemically important banks (G-SIBs) is to select the valuation techniques associated with a lower level of risk. Conversely, the optimal strategy for the non-G-SIBs is to select the valuation techniques associated with a higher level of risk. Finally, we demonstrate that the above optimal strategies are consistent over time. These findings are in line with the regulators' mindset to reduce the balance sheet riskiness of G-SIBs.