The Relationship between Fair Value, Market Value, and Efficient Markets*

ABSTRACT This paper proposes that an assumption of reasonable market efficiency is at the essence of the relevance of fair value for financial reporting purposes. The paper's examination of this proposal begins with a review of recent academic literature on market efficiency, and on evidence of inefficiencies and their implications for the ability of the efficient market hypothesis to explain what market prices represent. It concludes that there is wide acceptance in this literature that a reasonable level of efficiency can generally be presumed to exist in active, well‐regulated capital markets. The paper examines the essential attributes of a reasonably efficient market for fair value measurement purposes, and some basic implications for its reliable estimation. This is done in comparison with the provisions of the fair value measurement standard of the Financial Accounting Standards Board (FASB) ( Statement of Financial Accounting Standards SFAS No. 157 ). It is concluded that the concept of reasonable market efficiency could provide a sound conceptual framework for defining fair value that is founded in real, observable market prices. It is demonstrated that, in contrast, SFAS No. 157 does not provide a clear, unequivocal concept of fair value, and that it permits estimates of fair value that have no demonstrable basis in real, observable market prices. Nevertheless, it appears that arguments typically put forward by the International Accounting Standards Board and the FASB for the relevance of fair value for financial reporting purposes do imply a presumption of reasonably efficient markets.