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

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

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

48 Scopus citations

Abstract

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.

Original languageEnglish (US)
Pages (from-to)64-75
Number of pages12
JournalJournal of Monetary Economics
Volume57
Issue number1
DOIs
StatePublished - Jan 1 2010

Keywords

  • Mark-to-market accounting
  • Price of risk

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics

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