Where Does the Information in Mark-to-Market Come From?

42 Pages Posted: 18 Nov 2009 Last revised: 10 Dec 2016

Alexander Bleck

University of British Columbia - Sauder School of Business

Pingyang Gao

University of Chicago - Booth School of Business

Date Written: October 30, 2016

Abstract

We study the effects of mark-to-market accounting (MTM) on banks’ loan origination and retention decisions. We point out a conceptual shortcoming of MTM. Loan prices are informative in equilibrium but this price discovery is sustained by the good banks’ costly retention. The attempt to exploit the information in equilibrium prices through MTM makes price discovery more costly or even impossible. We show that, relative to historic cost accounting (HC), MTM has three consequences. First, it improves the accuracy of loan valuation ex post. Second, it forces the good banks to retain even more risk exposure on their balance sheet. Finally, it can reduce ex-ante origination efforts. To the extent that a lower loan quality and banks’ excessive risk exposure are two important ingredients for financial crises, we identify one mechanism through which MTM could contribute to financial crises.

Keywords: Mark-to-market accounting, historic cost accounting, loan quality, financial crisis

JEL Classification: G01, G21, G30, M41

Suggested Citation

Bleck, Alexander and Gao, Pingyang, Where Does the Information in Mark-to-Market Come From? (October 30, 2016). Chicago Booth Research Paper #10-06. Available at SSRN: https://ssrn.com/abstract=1507342 or http://dx.doi.org/10.2139/ssrn.1507342

Alexander Bleck (Contact Author)

University of British Columbia - Sauder School of Business ( email )

Canada
604-827-3452 (Phone)

Pingyang Gao

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

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