Mark-to-market accounting and liquidity pricing

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...

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Bibliographic Details
Published in:Journal of accounting & economics 2008-08, Vol.45 (2), p.358-378
Main Authors: Allen, Franklin, Carletti, Elena
Format: Article
Language:English
Subjects:
Accounting
Asset pricing
Bank liquidity
Earnings
Financial institutions
Historical cost
Incomplete markets
Insurance companies
Liability
Liquidity
Mark to market accounting
Mark-to-market
Market prices
Market structure
Pricing policies
Solvency
Studies
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Summary: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.
ISSN:0165-4101
1879-1980
DOI:10.1016/j.jacceco.2007.02.005