What it is:
How it works (Example):
The mark-to-model pricing method puts a value on assets based on the outcome of a financial model. It can also take into account historical price forecasts calculated from the same model. For this reason, mark-to-model prices are estimates grounded in theory.
Mark-to-model is often applied to assets that trade in very illiquid markets. For example, bonds issued on the private market do not trade very often. Because the private bond market is quite illiquid, it is generally appropriate to value those specific types of bonds on a mark-to-model basis.
Why it Matters:
Mark-to-model is a risky and controversial method, especially when it is used to price assets that trade in a liquid, but declining market. Mark-to-model lends itself to subjective analysis at the individual level, without taking into account how the larger pool of buyers and sellers is actually valuing an asset. In other words, given the assumptions that a pricing model is comprised of, individuals may not agree on the accuracy of asset prices.
The credit crisis of the late 2000s, mortgages and mortgage-backed securities lost much of their perceived value in a short time span. The Federal Accounting Standards Board (FASB) chose to suspend mark-to-market accounting in favor of mark-to-model or mark-to-management accounting in order to give financial institutions leeway when putting a value on mortgages and MBSs in a tumultuous market.