Did Fair Valuation Depress Equity Values During the 2008 Financial Crisis?

Abstract

We investigate the assertion that fair valuation of financial instruments exacerbated the 2008 financial crisis. We focus on the 4th quarter of 2008 following the Lehman Brothers bankruptcy, the Reserve Primary fund “breaking the buck” and other adverse events. Our central finding is that firms with higher percentage of assets fair valued had higher abnormal stock returns. Both fair value level 1 and level 2 measurements are positively associated with stock returns. We show that fair valuation is widespread not only in financial firms but also in industrial firms and that the above results hold for both financial and industrial firms. We do not find evidence that these results are driven by a specific subsample, mean reversion in stock returns, anticipation of the crisis, or liquidity factors alone. Our findings are inconsistent with fair valuation depressing equity values.

Keywords: fair value, financial instruments, financial crisis, stock returns

JEL Classification: G12, G14, G21, M41