how shadow pricing works
shadow pricing as it relates to money market funds refers to the practice of accounting the price of securities based on amortized costs rather than on their assigned market value money market fund shares are always assigned a nominal net asset value nav of 1 even though the actual nav falls slightly above or below this figure such funds are required by law to disclose the actual nav the shadow share price to show the fund s performance to investors more accurately however the use of the term shadow price in relation to money market funds is the less common usage of the phrase it is more frequently applied in the process of cost benefit analysis in business decision making in its most common usage a shadow price is an artificial price assigned to a non priced asset or accounting entry shadow pricing is frequently guided by certain assumptions about costs or value it is generally a subjective and inexact or imprecise endeavor to make a decision regarding the undertaking of a project or investment businesses often perform a comparative analysis of the project or investment cost against the projected benefits in performing a cost benefit analysis a business must often account for the costs or benefits of intangible assets that are difficult to assign a dollar value to but that must nonetheless be monetarily quantified for the purpose of performing the analysis economists will often assign a shadow price to estimate the cost of negative externalities such as the pollution emitted by a firm advantages and disadvantages of shadow pricingusing shadow pricing helps a business obtain a fuller understanding of its project s real value it is a necessary part of running a cost benefit analysis and can assist management in their decisions about various aspects of a project s strategy and scope shadow pricing encourages responsible ethical behavior and is a vital tool in accurately evaluating a project that being said there are a number of limitations to shadow pricing most notably shadow pricing is inherently subjective because the assets it attempts to value are intangible the shadow price is proofless furthermore because analysts must employ a fair amount of guesswork there is significant room for bias this means there is also a good chance the shadow price is not accurate if the methodology used to create the shadow price is flawed the business may direct its actions in a way that won t benefit and could discredit the company finally some critics believe shadow pricing puts too much emphasis on short term social opportunity cost while ignoring the long term priorities of the business encourages financially pragmatic business actionsvital tool to running cost benefit analysishelps companies be more proactiveoften inaccurateleaves room for bias in shadow pricing methodologymay be too rigid