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Book vs. Fair Value Accounting in Banking, and Intertemporal Smoothing

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Xavier Freixas
Dimitrios P. Tsomocos

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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.

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Paper provided by Oxford Financial Research Centre in its series OFRC Working Papers Series with number 2004fe13.

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Date of creation: 2004
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Handle: RePEc:sbs:wpsefe:2004fe13

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Philippe Aghion, Patrick Bolton & Steven Fries, 1999. "Optimal Design of Bank Bailouts: The Case of Transition Economies," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 155(1), pages 51-, March.
  2. Paul A. Samuelson, 1958. "An Exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money," Journal of Political Economy, University of Chicago Press, vol. 66, pages 467. [Downloadable!] (restricted)
  3. Gorton, Gary & Pennacchi, George, 1990. " Financial Intermediaries and Liquidity Creation," Journal of Finance, American Finance Association, vol. 45(1), pages 49-71, March. [Downloadable!] (restricted)
  4. Andrea Enria & Lorenzo Cappiello & Frank Dierick & Sergio Grittini & Andrew Haralambous & Angela Maddaloni & Philippe Molitor & Fatima Pires & Paolo Poloni, 2004. "Fair value accounting and financial stability," Occasional Paper Series 13, European Central Bank. [Downloadable!]
  5. Franklin Allen & Douglas Gale, 1995. "Financial Markets, Intermediaries, and Intertemporal Smoothing," Center for Financial Institutions Working Papers 95-02, Wharton School Center for Financial Institutions, University of Pennsylvania. [Downloadable!]
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  6. Qi, Jianping, 1994. "Bank Liquidity and Stability in an Overlapping Generations Model," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 7(2), pages 389-417. [Downloadable!] (restricted)
  7. Sudipto Bhattacharya & Paolo Fulghieri & Riccardo Rovelli, 1998. "Financial Intermediation Versus Stock Markets in a Dynamic Intertemporal Model," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 154(1), pages 291-, March.
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  8. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June. [Downloadable!] (restricted)
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  1. Franklin Allen & Elena Carletti, 2006. "Mark-to-Market Accounting and Liquidity Pricing," CFS Working Paper Series 2006/17, Center for Financial Studies. [Downloadable!]
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  2. Vincent Bouvatier & Laetitia Lepetit, 2006. "Banks' procyclicality behavior : does provisioning matter ?," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00115622_v1, HAL. [Downloadable!]
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