Mark-to-market valuation vs. fair value accounting

Companies and their business, control and support functions require price information in order to start certain periodic procedures and to generate various reports. The most reliable ingredients may be up-to-date prices, not historical costs. Valuating a position mark-to-market concerns accounting against actual market prices. Hence, it must be updated over-and-over. However, when products are hardly traded, and/or products are traded in a market without price transparency, then, what is the ‘realistic’ or ‘correct’ price of a product? What is the ‘fair’ value?

It should be noted that most prices will be outdated quickly. First, however, several types of market prices should be distinguished. The last-traded price is one, the bid price and the ask price are number two and three, while the mid-price forms another possibility (i.e. the average of the best bid price and the best ask price). Alternatively, one can consider the settlement price or an index as a price reference.

Professional organisations can find market prices at trading platforms, purchase data from data vendors, or derive market data from various sources of media (e.g. the Internet, newspapers, etcetera). However, it is important to understand whether these data concern the bid price, the ask price, the mid-price or, for instance, the last traded price. What procedure is in place to generate market data? In this respect, settlement price calculation procedures and index calculation procedures help out.

The reliability or accuracy of the data depends on many factors. In case of mid prices, one may wonder how representative these are to reflect what the fair price is. One could argue, for instance, that the larger the bid-ask spread, the less usable the mid-price as proper reference.

Depending on the position of a market participant it may have a preferred methodology to valuate positions.