EconPapers    
Economics at your fingertips  
 

Mark-to-market accounting and systemic risk: evidence from the insurance industry

Andrew Ellul, Chotibhak Jotikasthira, Christian T. Lundblad and Yihui Wang

Economic Policy, 2014, vol. 29, issue 78, 297-341

Abstract: type="main" xml:id="ecop12030-abs-0001"> One of the most contentious issues raised during the recent crisis has been the potentially exacerbating role played by mark-to-market accounting. Many have proposed the use of historical cost accounting, promoting its ability to avoid the amplification of systemic risk. We caution against focusing on the accounting rule in isolation, and instead emphasize the interaction between accounting and the regulatory framework. First, historical cost accounting, through incentives that arise via interactions with complex capital adequacy regulation, does generate market distortions of its own. Second, while mark-to-market accounting may indeed generate fire sales during a crisis, forward-looking institutions that rationally internalize the probability of fire sales are incentivized to adopt a more prudent investment strategy during normal times which leads to a safer portfolio entering the crisis. Using detailed, position- and transaction-level data from the US insurance industry, we show that (a) market prices do serve as ‘early warning signals’, (b) insurers that employed historical cost accounting engaged in greater degrees of regulatory arbitrage before the crisis and limited loss recognition during the crisis, and (c) insurers facing mark-to-market accounting tend to be more prudent in their portfolio allocations. Our identification relies on the sharp difference in statutory accounting rules between life and P&C companies as well as the heterogeneity in implementation of these rules within each insurance type across US states. Our results indicate that regulatory simplicity may be preferred to the complexity of risk-weighted capital ratios that gives rise, through interactions with accounting rules, to distorted risk-taking incentives and potential build-up of systemic risk. — Andrew Ellul, Chotibhak Jotikasthira, Christian T. Lundblad and Yihui Wang

Date: 2014
References: Add references at CitEc
Citations: View citations in EconPapers (16) Track citations by RSS feed

Downloads: (external link)
http://hdl.handle.net/10.1111/ecop.2014.29.issue-78 (text/html)
Access to full text is restricted to subscribers.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:bla:ecpoli:v:29:y:2014:i:78:p:297-341

Ordering information: This journal article can be ordered from
http://www.blackwell ... bs.asp?ref=0266-4658

Access Statistics for this article

Economic Policy is currently edited by Giuseppe Bertola, Philippe Martin and Paul Seabright

More articles in Economic Policy from CEPR Contact information at EDIRC., CES Contact information at EDIRC., MSH Contact information at EDIRC.
Bibliographic data for series maintained by Wiley Content Delivery ().

 
Page updated 2020-05-29
Handle: RePEc:bla:ecpoli:v:29:y:2014:i:78:p:297-341