Q&A: by Fama/French Forum

Q&A: Thoughts on Mark-to-Market

by Fama/French Forum

1、What do you think of the mark to market issue?

EFF: It gives investors a good estimate of what a financial institution is worth. It has more flexibility than commonly realized, especially for illiquid assets, where best estimates of value can be used.

KRF: There is not enough empirical evidence to be sure who is right about this issue, but we can guess. Those against marking to market argue that the transaction prices for securities sold under duress do not reflect their true value. If you and I both own relatively illiquid assets and you choose to sell yours quickly at a fire sale price, mark to market accounting may force me to write down the value of my assets to your transaction price. Unless I also plan to sell my position quickly, this undervalues my position. The critical question, however, is whether your transaction price is more accurate than the model value I would use if I am not forced to mark to market. My guess—and this is only a guess—is that the observed transaction price is typically more accurate than the model. In other words, marking to market would improve the accuracy of my balance sheet.

Acconomics：mark to market,会在交易双方疯狂的时候失灵。比如说，股市上涨，大家都认为未来会上涨，下跌，都认为未来会下跌。这种预期是错误的，但是交易价格是基于这种预期的！

2、I have a client who is convinced that an inverted yield curve is a signal to get out of equities. What are your thoughts on this topic?

EFF/KRF: Inverted yield curves are often observed at the front end of recessions. But there's no evidence that they predict stock returns, which also tend to predict (decline in advance of) recessions. Your client's implicit premise is that bond market investors predict future economic activity better than stock market investors. The evidence says that both markets are moderately good at predicting future economic activity, and inverted yield curves are not reliable predictors of stock returns.

3、Recently, I've heard some say "I got out of the market in May 2008 and I am sure glad I did." Given the obviously positive results of this decision, what is the best argument to convince people that buy and hold is better than timing the market?

EFF: Wins and losses from market timing bets are both just unpredictable chance outcomes, and good luck is, of course, better than bad luck. The problem with market timing is that you may be out of the market in periods of strong returns.

KRF: There is a large academic literature on whether market returns are predictable. The general conclusion is that it is impossible to predict the market return with any confidence... "A Comprehensive Look at the Empirical Performance of Equity Premium Prediction," by Amit Goyal and Ivo Welch (Review of Financial Studies, 2008), is a good summary of the evidence.

Acconomics：buy and hold the SOC\big company if you have no inner information; trade based on inner information if you have