The Reliability of Fair Value versus Historical Cost Information:
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The Reliability of Fair Value versus Historical Cost Information: Evidence from Closed-End Mutual Funds. Presented by: Ira Geraldina Nova Novita Intan Oviantari. Introduction. Research Questions & Theoretical Frameworks. Methodology. Outline. Results. Conclussions. Introduction.

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The Reliability of Fair Value versus Historical Cost Information: Evidence from Closed-End Mutual Funds

Presented by:

Ira Geraldina

Nova Novita

Intan Oviantari


Introduction Information:

Research Questions & Theoretical Frameworks

Methodology

Outline

Results

Conclussions


Introduction Information:

  • Opponents of fair value measurement:

  • Reliability problems for some fair

  • value estimates

  • Suggest that these instruments are

  • recognized at historical cost

JWA, Basis for Conclusions:

fair value more relevant

than historical cost

fair value represents unbiased

measured (consistent within year

and between enterprise)

economic effect of risk is

reflected in current period

income

Fair value is measured at market

price or based on estimates

(FASB)

Recognizing fair value in the

Balance Sheet (JWG)

Subjective in estimate far value

for non-traded instrument (IASC)

  • Proponents of fair value measurement:

  • Fair value valuation has more

  • advantages than historical cost


Research questions

Primary Research Questions: Information:

When compared to historical measures, is the value

relevance of some financial instrument (Closed-End

Mutual Funds) fair values eliminated due to

reliability issues relating to fair value estimation?

Research Questions


Research questions 1

ONA Information:

PRICE

HC

FV

Research Questions-1


Research questions 2

INC Information:

GRL

FVGL

Research Questions-2

RETURN


Research questions 3
Research Questions-3 Information:

Reliability across fund types:

  • G7PUB

  • NG7FUB

  • GOV

  • CBONDS

  • OTHER

  • UNCLASS


Theoretical framework
Theoretical Framework Information:


Carroll at al 2002 vs previous studies

Carroll at al (2002) used closed end mutual funds which has Information:

several advantages:

  • Provide sufficient data to evaluate the incremental

    informativeness of both fair value balance sheet and

    income statement information

  • Potential problem with correlated omitted variables

    Is basically nonexistent

  • There is great variation in the securities invested in by

    different funds

Carroll at al (2002) Vs Previous Studies

  • The results support the hypotheses

  • Solve the problem of previous studies about omitted variables

  • Explain that reliability problems in measuring the fair values

    of investment are not the primary explanation for the

    inconsistency in prior results


General description
General Description Information:

Open-End

Mutual Funds

Closed-End


General description1
General Description Information:

  • Closed-End:

  • Companies operate more like

  • a traditional companies

  • Shares are available only for

  • trade in secondary market

  • Subsequent purchases and sales

  • of shares do not effect the equity

  • and assets of the fund

  • The traded price may fluctuate in

  • response to supply and demand

  • Trade at discount/premium

  • Open-End:

  • Companies issue and redeem

    shares at the current market value

    per share

  • There is no secondary trading

    market

  • Equity capitalization and net

    assets are directly changed by

    magnitude of the traded share

    price when shares sold or redeem


General description2

Discount/premium has been widely Information:

studied over 30 years

General Description

Early explanation of discount/

premium focused on problem

of measuring NAV


They derive from managerial performance that are not reflected in NAV

(Boudreaux, 1973; Ingersoll, 1976; Chance, 1997)

Discount/premium explanations

Tax liability on unrealized capital appreciation does not

show up in NAV (Malkiel, 1977)

Liquid asset are overvalued in NAV (Malkiel, 1977)

Indicate mispricing regarding individual investor sentiments cause

systematic noise trading (Lee, Shleifer, Thaler, 1991)

Mispricing exist in the presence of rational traders who taking full

advantages of mispricing


Accounting requirement
Accounting Requirement reflected in NAV


Accounting requirement1
Accounting Requirement reflected in NAV


Accounting requirement2
Accounting Requirement reflected in NAV



Descriptive statistics
Descriptive statistics reflected in NAV


Table 2
Table 2 reflected in NAV

Data is segregated into six fund-types.

Panel A presents descriptive statistics for each fund-type (S&P)

Panel B list the number of funds by type for each year in our sample.


Empirical tests
Empirical tests reflected in NAV


Empirical tests1
Empirical tests reflected in NAV


Empirical tests2
Empirical tests reflected in NAV

The Results:

FV = Positive and significant

HC = not significant.

Use standard errors that are adjusted for heteroskedasticity and serial correlation according to Newey and west.


Reliability test

Investment Securities Fair Value Gains and Losses reflected in NAV

Reliability Test

Reliability Across Fund Type


Investment securities fair value gains and losses test
Investment Securities Fair Value Gains and Losses Test reflected in NAV

Using Earning Capitalization Model to determine if

investor view income statement fair value security

gains and losses as value relevance in a setting

with no correlated omitted variables.

Fair Value Income

FVGL

INC


Earning capitalization model
Earning Capitalization Model reflected in NAV

Rit = γ1t + γ2 INCit + γ3 RGLit + γ4 FVGLit + εit² (3)


Tabel 4 investment securities fair value gains and losses test
Tabel 4. reflected in NAVInvestment Securities Fair Value Gains and Losses Test

Panel A

Separately Yearly Regression

Panel B

Pooled Estimation

Rit = γ1t + γ2 INCit + γ3 RGLit + γ4 FVGLit + εit²

Mean R² 0,68

Mean n= 65

White’s (1980) Adjusted Standar Errors as needed

Rit = γ1t + γ2 INCit + γ3 RGLit + γ4 FVGLit + εit²

Mean R² = 0,67

Mean n= 971

Newey-West (1987) Adjusted Standar Errors

In the close-end mutual fund setting, Carrol et al find that fair value

securities gains and losses consistently provide information incremental

to historical cost income measures


Reliability across fund types test
Reliability Across Fund Types Test reflected in NAV

The researcher examine the incremental informativeness of balance sheet and

income statement fair value s by modifying the price and returns regressions specified previously to allow the intercept and all of the coefficient to vary across the six fund types.

Rit = γ1t + γ2 INCit + γ3 RGLit + γ4 FVGLit + εit² (3)

Pit = β 1t + β2t ONAit + β3t HCit + β 4t FVit + it²(2)


Tabel 5 reliability across fund types test
Tabel 5. reflected in NAVReliability Across Fund Types Test

Coefficient Estimate t statistic based on Newey-West (1987) adjusted standar errors

Return Regression

Price Regression

Rit = γ1t + γ2 INCit + γ3 RGLit + γ4 FVGLit + εit²

Mean R² = 0,67

Mean n= 971

Newey-West (1987) Adjusted Standar Errors

Pit = β1t + β2t ONAit + β3t HCit + β4t FVit + it²

Mean R² = 0,94

Mean n= 1118


Reliability across fund types result
Reliability Across Fund Types Result reflected in NAV

Table 5 result consistent with fair value providing information incremental to

Historical cost for both balance sheet and income statement information

This finding is consistent with investor perceiving that the fair value estimates

for equities traded in less active markets, such as private markets

and markets in non G7 countries are less reliable than fair value of

publicly traded equity securities from G7 countries

that are traded in active markets


Conclusion

  • Provide evidence consistent with close-end investors viewing fair value estimates for

  • G7 publicly traded equities as more reliable than those for private and non-G7 equities.

  • The reliability problem in measuring fair value of investment securities are not the

  • primary explanation for the inconsistency in prior research result, instead incomplete

  • availability of fair value measures in other settings.

Conclusion

  • Suggest to standard setters : their greatest challenge in requiring the recognition of all

  • financial instruments at fair value may not be the reliable estimation of the fair value

  • of investment security assets not traded in active market.

  • This economic problem is virtually absent in their setting because all the net assets

  • of close-end mutual funds are recognized in financial statements at their fair value

  • or its equivalent. .


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