Direct Contagion in Financial Networks with Mark-to-Market and Historical Cost Accounting Rules


  •  Mario Eboli    

Abstract

In this paper we compare the effects of two accounting rules, the mark-to-market and the historical cost regimes, on the dynamics of direct, balance sheet contagion in financial networks. This is done using a flow-network representation of a financial system and of the propagation of losses that crosses it as a consequence of a negative shock. We show that, for any network and any shock, the flow of losses generated with the mark-to-market rule is larger than the one generated by accounting at historical cost. This implies that a financial network is more exposed to default contagion, both in terms of scope and threshold of contagion, under the marking-to-market accounting regime, than with the historical cost regime.



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