Should financial institutions mark-to-market?

Franklin Allen and Elena Carletti ()

Financial Stability Review, 2008, issue 12, 1-6

Abstract: There has been a spirited debate about the merits of mark-to-market accounting for financial institutions for some time now. Many argue that market prices provide the best estimate of value available and should always be used. However, others suggest that in times of crisis market prices are not a good reflection of value and their use can lead to serious distortions. This article explains the circumstances where market prices do reflect future earning power and those where market imperfections imply that they do not. We suggest that in financial crisis situations where liquidity is scarce and prices are low as a result, market prices should be supplemented with both model-based and historic cost valuations. The rest of the time and in particular when asset prices are low because expectations of future cash flows have fallen, mark-to-market accounting should instead be used.

Date: 2008
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