Information Asymmetry of Fair Value Accounting During the Financial Crisis

We examine whether US banks' fair value net assets, measured according to the three-level hierarchy introduced in SFAS 157, are associated with information asymmetry during the 2008 financial crisis. Our results show that bid-ask spread, a proxy for information asymmetry, is positively associated with fair value net assets, and the degree of association is contingent upon the three-level hierarchy, with bid-ask spreads being lowest for Level 1 (the most transparent valuation inputs) and highest for Level 3 (the least observable). Also, there is some evidence that SFAS 157 led to a reduction in bid-ask spread, and we find that quarterly changes in Level 1 and Level 2 fair value net assets are significantly associated with changes in bid-ask spread in 2008 when the spread was rapidly rising, but not in 2009 when it was falling. Our findings suggest that the three-level hierarchy under SFAS 157 provides investors with useful information, and fair value is associated with uncertainty, as measured by bid-ask spread, before and during the financial crisis