What is Mark to Model?

Mark to model is a term used to evaluate the pricing associated with a particular investment based on financial models employed by the investor. The idea behind this type of strategy is to determine the projected benefit to the investment portfolio based on the assumptions made by using a given financial model. Investors tend to utilize this mark to model approach when it is not possible to utilize the more common mark to market model, which draws conclusions based on historic or current activity within a specified marketplace.

While some amount of conjecture and assumption is made in projecting the future trend of pricing on investments, the mark to model approach tends to rely on assumption to a greater degree than the mark to market strategy. With the lack of historical data used to evaluate pricing based on what has happened in the past and what is happening now, investors must interpret whatever data is available and form assumptions or hunches in order to determine an equitable price for the asset and where that price will move in the future. Successfully using this strategy does require the investor to accurately interpret the nature of the model used in the evaluation. Failure to do so will often mean little to no returns are generated in the future, and the investor may even sustain a considerable loss.

When the value assumptions that are made with a mark to model approach do prove accurate, it is possible to generate a great deal of return over time. This is particularly true with investment opportunities like securitized mortgages. Should the model selection and evaluation prove to be practical, the investor can enjoy a steady return over an extended period of time. By contrast, the degree of risk is significant and should the model interpretation prove faulty, this may mean the necessity of writing off a huge number of the mortgages from company balance sheets, resulting in losses that are difficult if not impossible to recover.

The enhanced risk associated with assets evaluated using a mark to model approach have led some nations to enact legislation regarding the disclosure of these assets on company balance sheets. This makes it easier for investors to be aware of these types of assets when considering investing in a given company and have a better idea of how to assess the potential of that investment. Depending on the nature and scope of the legislation, only publicly traded companies may be required to make this type of disclosure to current and prospective investors.