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Mark-to-market accounting and liquidity pricing

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  • Allen, Franklin
  • Carletti, Elena

Abstract

When liquidity plays an important role as in financial crises, asset prices may reflect the amount of liquidity available rather than the asset's future earning power. Using market prices to assess financial institutions' solvency in such circumstances is not desirable. We show that a shock in the insurance sector can cause the current market value of banks' assets to fall below their liabilities so they are insolvent. In contrast, if values based on historic cost are used, banks can continue and meet all their future liabilities. We discuss the implications for the debate on mark-to-market versus historic cost accounting.

Suggested Citation

  • Allen, Franklin & Carletti, Elena, 2008. "Mark-to-market accounting and liquidity pricing," Journal of Accounting and Economics, Elsevier, vol. 45(2-3), pages 358-378, August.
    • Handle: RePEc:eee:jaecon:v:45:y:2008:i:2-3:p:358-378
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    References listed on IDEAS

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    1. Dimitrios P Tsomocos & Xavier Freixas & Universitat Pompeu Fabra and CEPR, 2004. "Books vs. Fair Value Accounting in Banking, and Intertemporal Smoothing," Economics Series Working Papers 2004-FE-13, University of Oxford, Department of Economics.
    2. Allen, Franklin & Carletti, Elena, 2006. "Credit risk transfer and contagion," Journal of Monetary Economics, Elsevier, vol. 53(1), pages 89-111, January.
    3. Bagehot, Walter, 1873. "Lombard Street: A Description of the Money Market," History of Economic Thought Books, McMaster University Archive for the History of Economic Thought, number bagehot1873.
    4. Franklin Allen & Douglas Gale, 2005. "From Cash-in-the-Market Pricing to Financial Fragility," Journal of the European Economic Association, MIT Press, vol. 3(2-3), pages 535-546, 04/05.
    5. Guillaume Plantin & Haresh Sapra & Hyun Song Shin, 2008. "Marking‐to‐Market: Panacea or Pandora's Box?," Journal of Accounting Research, Wiley Blackwell, vol. 46(2), pages 435-460, May.
    6. Franklin Allen & Douglas Gale, 2004. "Financial Intermediaries and Markets," Econometrica, Econometric Society, vol. 72(4), pages 1023-1061, July.
    7. Franklin Allen & Douglas Gale, 1998. "Optimal Financial Crises," Journal of Finance, American Finance Association, vol. 53(4), pages 1245-1284, August.
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    More about this item

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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