Marking to Market: Panacea or Pandora's Box?
University of Toulouse 1 - Toulouse School of Economics (TSE)
University of Chicago - Booth School of Business
Hyun Song Shin
Bank for International Settlements; Princeton University - Department of Economics
August 13, 2007
Journal of Accounting Research, Vol. 46, No. 2, pp. 435-460, 2008
Financial institutions have been at the forefront of the debate on the controversial shift in international standards from historical cost accounting to mark-to-market accounting. We show that the trade-offs at stake in this debate are far from one-sided. While the historical cost regime leads to some inefficiencies, marking to market may lead to other types of inefficiencies by injecting artificial risk that degrades the information value of prices, and induces sub-optimal real decisions. We construct a framework that can weigh the pros and cons. We find that the damage done by marking to market is greatest when claims are (i) long-lived, (ii) illiquid, and (iii) senior. These are precisely the attributes of the key balance sheet items of banks and insurance companies. Our results therefore shed light on why banks and insurance companies have been the most vocal opponents of the shift to marking to market.
Number of Pages in PDF File: 32
JEL Classification: M41, M44, M47, G21, G22
Date posted: July 30, 2008 ; Last revised: November 11, 2010