Fair value, also called fair price, is a concept used in finance and economics.
It is considered by supporters to be a rational and unbiased estimate of the potential market price of a good, a service, a financial asset, etc., taking into account such elements as, among others:
its production / distribution costs,
its usefulness (for goods and services)
its financial return (for assets), or what economists call utility (return / risk balance)
its rarity.
Fair value vs market price
There are two schools of thought about the relation between the market price and the fair value, at least as concerns financial assets:
The efficient market hypothesis, asserting that, in a well organized and well informed market, the market price is equal or close to the fair value, as investors react immediately and adequately to any outside information
Behavioral finance that states, on the contrary, that the market price diverges quite often and largely from the fair value, because of various collective cognitive or emotional biases affecting investors.
Under GAAP, the fairvalue of an asset is the amount at which that asset could be bought or sold in a current transaction between willing parties, other than in a liquidation.
On the other side of the balance sheet, the fairvalue of a liability is the amount at which that liability could be incurred or settled in a current transaction between willing parties, other than in a liquidation.
Maybe, if companies in the United States and Asia had measured all financial instruments at fairvalue, regulators, depositors, and investors could have achieved greater regulatory and market discipline and avoided some of the losses that investors and taxpayers have had to pay during previous downturns in the economy.
Fairvalues may be used as an analytic tool in the lending process and are compared with historical cost values.
If the hedged asset were measured at fairvalue, the changes in values of the hedged item and the credit derivative may offset each other, reducing the volatility that arises when only the derivative is marked to market and not the hedged item.
While at first glance the fairvalue option might be viewed as "the solution" to addressing the problems of the mixed-attribute model, it also raises a number of concerns.
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