Marking to Market, Liquidity, and Financial Stability

We are grateful to the discussants, Eli M. Remolona and George Pickering, and to other participants for their comments. Hyun Song Shin was Resident Scholar at the IMF during the preparation of this paper, and he thanks the IMF Research Department for its hospitality. 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