Marking-to-Market: Panacea or Pandora's Box?


  • We are grateful to both our editor, Ray Ball, for his advice and comments and to an anonymous referee for many useful comments. We also thank participants at the 2007 Journal of Accounting Research conference as well as participants in various seminars, and, in particular, Doug Diamond, Ron Dye, Xavier Freixas, Milt Harris, Charles Goodhart, Raghu Rajan, Rafael Repullo, Jean-Charles Rochet, and Lars Stole for their comments. Catherine Xu provided excellent research assistance. Sapra acknowledges financial support from the FMC Faculty Research Fund at the Graduate School of Business, the University of Chicago. Shin acknowledges support from the United Kingdom Economic and Social Research Council under its World Economy and Finance Programme.


Financial institutions have been at the forefront of the debate on the controversial shift in international standards from historical cost accounting to mark-to-market accounting. We show that the trade-offs at stake in this debate are far from one-sided. While the historical cost regime leads to some inefficiencies, marking-to-market may lead to other types of inefficiencies by injecting artificial risk that degrades the information value of prices, and induces suboptimal real decisions. We construct a framework that can weigh the pros and cons. We find that the damage done by marking-to-market is greatest when claims are (1) long–lived, (2) illiquid, and (3) senior. These are precisely the attributes of the key balance sheet items of banks and insurance companies. Our results therefore shed light on why banks and insurance companies have been the most vocal opponents of the shift to marking-to-market.