Fair Value Accounting Measurement Reliability and Market Volatility Effects

Abstract

This research investigates the complex relationship between the reliability of fair
value accounting measurements and their subsequent effects on market volatility, a
topic that remains underexplored in the accounting literature. While prior studies
have examined the general impact of fair value accounting on financial reporting, this
paper uniquely focuses on the measurement reliability spectrum—from Level 1 (observable market prices) to Level 3 (unobservable model-based inputs)—and how different
reliability levels asymmetrically influence market behavior during periods of economic
stress. We develop a novel methodological framework that integrates accounting measurement theory with behavioral finance principles, creating a hybrid approach that
captures both the technical measurement challenges and the psychological market responses. Our research employs a multi-method design combining longitudinal analysis
of financial statement data from 1998-2004 with experimental simulations of investor
decision-making under varying measurement reliability conditions. The findings reveal
several original contributions: first, we demonstrate that Level 3 fair value measurements exhibit a paradoxical effect—while intended to provide more relevant information, they actually increase market volatility during downturns due to heightened
uncertainty and heterogeneous valuation models. Second, we identify a ”reliability
threshold” phenomenon where markets tolerate measurement uncertainty up to a specific point before reacting with disproportionate volatility. Third, we document that
the relationship between measurement reliability and market volatility is non-linear
and context-dependent, varying significantly across industry sectors and market conditions. These insights challenge conventional assumptions about fair value accounting’s
uniform effects and provide a more nuanced understanding of how measurement quality
interacts with market stability. The research contributes to both accounting theory and
financial market regulation by offering evidence-based recommendations for improving
measurement standards and disclosure requirements to mitigate unintended volatility
consequences while preserving the decision-usefulness of fair value information.