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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.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Accounting and Economics.

Volume (Year): 45 (2008)
Issue (Month): 2-3 (August)
Pages: 358-378

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Handle: RePEc:eee:jaecon:v:45:y:2008:i:2-3:p:358-378

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  1. 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.
  2. Allen, Franklin & Carletti, Elena, 2005. "Credit risk transfer and contagion," CFS Working Paper Series 2005/25, Center for Financial Studies (CFS).
  3. Guillaume Plantin & Haresh Sapra & Hyun Shin, . "Marking to Market: Panacea or Pandora’s Box ?," GSIA Working Papers 2005-E4, Carnegie Mellon University, Tepper School of Business.
  4. 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.
  5. Xavier Freixas & Dimitrios P. Tsomocos, 2004. "Book vs. Fair Value Accounting in Banking, and Intertemporal Smoothing," OFRC Working Papers Series 2004fe13, Oxford Financial Research Centre.
  6. Franklin Allen & Douglas Gale, 1976. "Optimal Financial Crises," Center for Financial Institutions Working Papers 97-01, Wharton School Center for Financial Institutions, University of Pennsylvania.
  7. Franklin Allen & Douglas Gale, 2004. "Financial Intermediaries and Markets," Econometrica, Econometric Society, vol. 72(4), pages 1023-1061, 07.
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