Value Relevance of Fair Values-Empirical Evidence of the Impact of Market Volatility

Abstract

This study examines empirically the effects of market volatility on the value relevance of fair values. Using the modified Ohlson model (1995) and a sample of U.S. financial companies for the period of 2008 to 2013, this study shows that fair values are priced at a significant discount when market volatility is high. Song (2013) shows analytically that the effectiveness of fair value accounting is negatively affected by market volatility. Findings of the current study suggest that investors understand the effects of market volatility on fair values and price them accordingly. The study extends the research on the determinants of the usefulness of fair values by looking beyond factors associated with the reliability of estimated fair values (Level 2 and Level 3 fair values). This study has practical implications: current accounting standards for fair value measurement acknowledge the limitations of the market as a source of fair values by offering a three-level fair value hierarchy with provisions for fair values to deviate from market prices. Findings of this study shed light on a previously little studied factor, that is, market volatility, on the usefulness of fair values.