The reaction of bank stock prices to news of derivatives losses by corporate clients

From March through May of 1994, several large nonfinancial firms announced millions of dollars in losses from derivatives deals, especially those arra nged by Bankers Trust. Accompanying these announcements and related news st ories were allegations that Bankers Trust had either misrepresented, lied, or deceived its clients. Using SUR methods, we investigate how these announ cements affected Bankers Trust and three portfolios of banks: dealers, nond ealers, and nonusers. Our results indicate significant cumulative abnormal returns of -12.14% (Bankers Trust), -5.56% (13 dealer banks), and -2.45% (3 2 nondealer, user banks). The evidence suggests an intra-industry, informat ion-transfer effect consistent with rational pricing. The replacement cost of derivative contracts is an important factor in explaining the variation in abnormal returns across banks. (C) 1999 Elsevier Science B.V. All rights reserved.