Fair Value: Your Value or Mine? An Observation on the Ambiguity of the Fair Value Notion Illustrated by the Credit Crunch

Current IFRSs define fair value as a transaction price. In imperfect markets, buyer’s and seller’s marginal prices, at which they are rationally willing to transact, differ. The transaction price can be every amount within the range between those prices. However, scenarios are conceivable in which no such range exists because the seller’s marginal price exceeds the buyer’s. In this scenario, no arm’s length transactions between knowledgeable, willing parties are possible. Such a scenario can be likely characterised by low liquidity and/or high information asymmetry and seems to be broadly consistent with what is recently referred to as the “credit crunch”. Under this scenario, the IFRS definition of fair value is not readily applicable. Two views are possible: Under view 1, fair value refers to the potential buyer’s marginal price. Although fair value does always exist conceptually, it negates the notion of two rationally acting parties. View 2 acknowledges that no arm’s length transaction is possible, resulting in the fair value notion not being applicable. If these two views are applied to the IFRS definition of an active market, view 1 results in markets that are always active. Only view 2 allows distinguishing between active and inactive markets.