Fair Value Accounting and Market Efficiency
25 Pages Posted: 15 Jan 2013
Date Written: January 15, 2013
This paper analytically examines how market efficiency affects the effectiveness of fair value accounting (FVA). Fair value accounting has been one of the most controversial accounting subjects. The recent global financial crisis highlights the disparity between the views of its supporters who see it as panacea and its critics who consider it a Pandora’s box. The research on FVA, with the mixed findings, also failed to yield a conclusive outcome. In the history of financial reporting FVA has fallen in and out of favor with regulatory bodies several times. It appears that the changes in regulatory position towards FVA tended to occur in the aftermath of a major financial crisis, suggesting that the effectiveness of FVA is affected by the state of market conditions. Using a simple model tracking the performance of a portfolio over a two-period investment cycle under fair value accounting and historical cost accounting (HCA) regimes respectively, this study finds that fair value accounting is more effective when the market efficiency level is high, and vice versa. The findings of this paper suggest a new dimension in future research of FVA and provide a possible reconciliation of the contradicting empirical results of the existing studies.
Keywords: Fair Value Accounting, Market Efficiency
JEL Classification: M40, M41
Suggested Citation: Suggested Citation