Discussion Paper Series 2005-E-11

Marking to Market, Liquidity, and Financial Stability

Guillaume Plantin, Haresh Sapra, Hyun Song Shin

This paper explores the financial stability implications of mark-to-market accounting, in particular its tendency to amplify financial cycles and the "reach for yield". Market prices play a dual role. Not only do they serve as a signal of the underlying fundamentals and the actions taken by market participants, they also serve a certification role and thereby influence these actions. When actions affect prices, and prices affect actions, the loop thus created can generate amplified responses - both in creating bubble-like booms in asset prices, and also in magnifying distress episodes in downturns.

Keywords: Marking to market; accounting regime; monetary policy; financial stability

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

Copyright © 2005 Bank of Japan All Rights Reserved.

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