Book vs. Fair Value Accounting in Banking and Intertemporal Smoothing

OFRC Working Paper No. 2004fe13

32 Pages Posted: 6 Mar 2005

See all articles by Xavier Freixas

Xavier Freixas

Universitat Pompeu Fabra; Centre for Economic Policy Research (CEPR); Barcelona Graduate School of Economics (Barcelona GSE)

Dimitrios P. Tsomocos

University of Oxford - Said Business School and St. Edmund Hall

Multiple version iconThere are 2 versions of this paper

Date Written: September 8, 2004

Abstract

The aim of this paper is to examine the pros and cons of book and fair value accounting from the perspective of the theory of banking. We consider the implications of the two accounting methods in an overlapping generations environment. As observed by Allen and Gale (1997), in an overlapping generation model, banks have a role as intergenerational connectors as they allow for intertemporal smoothing. Our main result is that when dividends depend on profits, book value ex ante dominates fair value, as it provides better intertemporal smoothing. This is in contrast with the standard view that states that, fair value yields a better allocation as it reflects the real opportunity cost of assets. Banking regulation play an important role by providing the right incentives for banks to smooth intertemporal consumption whereas market discipline improves intratemporal efficiency.

Keywords: Book value, Fair Value, Banking, Intertemporal Smoothing, Overlapping Generations

JEL Classification: D50, G21, M41

Suggested Citation

Freixas, Xavier and Tsomocos, Dimitrios P., Book vs. Fair Value Accounting in Banking and Intertemporal Smoothing (September 8, 2004). OFRC Working Paper No. 2004fe13. Available at SSRN: https://ssrn.com/abstract=676607 or http://dx.doi.org/10.2139/ssrn.676607

Xavier Freixas

Universitat Pompeu Fabra ( email )

Ramon Trias Fargas 25-27
Barcelona, 08005
Spain
+34 93 542 2726 (Phone)
+34 93 542 1746 (Fax)

HOME PAGE: http://www.econ.upf.es/~freixas

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

HOME PAGE: http://www.econ.upf.es/~freixas/more/personal1.htm

Barcelona Graduate School of Economics (Barcelona GSE) ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

Dimitrios P. Tsomocos (Contact Author)

University of Oxford - Said Business School and St. Edmund Hall ( email )

Park End Street
Oxford, OX1 1HP
Great Britain
+44 1865 288 932 (Phone)
+44 1865 288 805 (Fax)

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