Marking to Market, Liquidity, and Financial Stability

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.