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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 times of financial crisis, asset prices in some markets may reflect the amount of liquidity available in the market rather than the future earning power of the asset. Mark-to-market accounting is not a desirable way to assess the solvency of a financial institution in such circumstances. We show that a shock in the insurance sector can cause the current value of banks’ assets to be less than the current value of their liabilities so the banks are insolvent. In contrast, if historic cost accounting is used, banks are allowed to continue and can meet all their future liabilities. Mark-to-market accounting can thus lead to contagion where none would occur with historic cost accounting. --

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Bibliographic Info

Paper provided by Center for Financial Studies (CFS) in its series CFS Working Paper Series with number 2006/17.

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Date of creation: 2006
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Handle: RePEc:zbw:cfswop:200617

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Keywords: Mark-to-market; Historical Cost; Incomplete Markets;

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References

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  1. Guillaume Plantin & Haresh Sapra & Hyun Shin, . "Marking to Market: Panacea or Pandora’s Box ?," GSIA Working Papers, Carnegie Mellon University, Tepper School of Business 2005-E4, Carnegie Mellon University, Tepper School of Business.
  2. Franklin Allen & Douglas Gale, 1998. "Optimal Financial Crises," Journal of Finance, American Finance Association, American Finance Association, vol. 53(4), pages 1245-1284, 08.
  3. Dimitrios P Tsomocos & Xavier Freixas, 2004. "Books vs. Fair Value Accounting in Banking, and Intertemporal Smoothing," Economics Series Working Papers 2004-FE-13, University of Oxford, Department of Economics.
  4. Allen, Franklin & Carletti, Elena, 2005. "Credit risk transfer and contagion," CFS Working Paper Series 2005/25, Center for Financial Studies (CFS).
  5. Franklin Allen & Douglas Gale, 2003. "Financial Intermediaries and Markets," Center for Financial Institutions Working Papers, Wharton School Center for Financial Institutions, University of Pennsylvania 00-44, Wharton School Center for Financial Institutions, University of Pennsylvania.
  6. 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, McMaster University Archive for the History of Economic Thought, number bagehot1873.
  7. Franklin Allen & Douglas Gale, 2005. "From Cash-in-the-Market Pricing to Financial Fragility," Journal of the European Economic Association, MIT Press, MIT Press, vol. 3(2-3), pages 535-546, 04/05.
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