Stochastic fair value: Attributes and applications

Abstract

The International Financial Reporting Standards define the concept of assets' and liabilities' fair value. In the case of perfect competition market, the concept of fair value closely corresponds with the concept of the present value, paradigm of what was formulated by Irving Fisher: “The value of an asset always equals the future cash flow discounted at the opportunity cost of capital.” Zvi Bodie and Robert C. Merton offered the term “fundamental value” in order to distinguish between the market value and theoretical value calculated as present value. In the case when cash flow associated with definite asset is stochastic, the fair value is stochastic too. The stochastic models spread in the scientific literature. But the author has not met the concept of the stochastic fair value in scientific literature intended for accounting. In current paper what is the part of the research “Holistic approach to the fair value concept and estimation” the investigation of the stochastic fair value concept, attributes and applications is provided. The expected fair value and standard deviation of fair value, and volatilities of these both indicators as the primary characteristics of fair value are offered. Theoretical constructions, discussion, conclusions and recommendations are oriented to the theoretical and practical implementations in order to get from sample survey more information for interpretations and decision making. The theoretical application presented in the current paper is connected with the well-known MM theorem of Franco Modigliani and Merton Miller: “The value of firm does not depend on firm's capital structure”. It is proved that the MM theorem in case of the stochastic cash flows, generally speaking, does not hold. The practical application presented in the paper is connected with the fair value concept in the International Public Sector Accounting Standards. It is applied to the valuation of non-rivalrous free communal good.