Marking-to-Market: Panacea or Pandora's Box?

Guillaume Plantin (1, 2) , Haresh Sapra (3) , Hyun Song Shin (4)

1 London Business School
2 Tepper School of Business
3 University of Chicago
4 Princeton University

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 suboptimal 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 (1) long–lived, (2) illiquid, and (3) 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.

Domains: Economics and Finance

Guillaume Plantin, Haresh Sapra, Hyun Song Shin. Marking-to-Market: Panacea or Pandora's Box?. Journal of Accounting Research, 2008, 46 (2), pp.435 - 460. ⟨10.1111/j.1475-679X.2008.00281.x⟩. ⟨hal-03415803⟩