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Is mark-to-market accounting destabilizing? Analysis and implications for policy

  • Heaton, John C.
  • Lucas, Deborah
  • McDonald, Robert L.

Fundamental economic principles provide a rationale for requiring financial institutions to use mark-to-market, or fair value, accounting for financial reporting. The recent turmoil in financial markets, however, has raised questions about whether fair value accounting is exacerbating the problems. In this paper, we review the history and practice of fair value accounting, and summarize the literature on the channels through which it can adversely affect the real economy. We propose a new model to study the interaction of accounting rules with regulatory capital requirements, and show that even when market prices always reflect fundamental values, the interaction of fair value accounting rules and a simple capital requirement can create inefficiencies that are absent when capital is measured by adjusted book value. These distortions can be avoided, however, by redefining capital requirements to be procyclical rather than by abandoning fair value accounting and the other benefits that it provides.

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Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 57 (2010)
Issue (Month): 1 (January)
Pages: 64-75

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Handle: RePEc:eee:moneco:v:57:y:2010:i:1:p:64-75
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505566

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  1. 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, 05.
  2. John Moore & Nobuhiro Kiyotaki, . "Credit Cycles," Discussion Papers 1995-5, Edinburgh School of Economics, University of Edinburgh.
  3. Wayne Landsman, 2006. "Fair value accounting for financial instruments: some implications for bank regulation," BIS Working Papers 209, Bank for International Settlements.
  4. Xiong, Wei, 2001. "Convergence trading with wealth effects: an amplification mechanism in financial markets," Journal of Financial Economics, Elsevier, vol. 62(2), pages 247-292, November.
  5. 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.
  6. Anna Pavlova & Roberto Rigobon, 2008. "The Role of Portfolio Constraints in the International Propagation of Shocks," Review of Economic Studies, Oxford University Press, vol. 75(4), pages 1215-1256.
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