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\pard\li1920\ri0\sl-213\slmult0 \fs18\cf0\par\pard\li1920\ri0\sl-213\slmult0 \fs
18\cf0\par\pard\li1920\ri0\sl-213\slmult0 \fs18\cf0\par\pard\li1920\ri0\sl-213\s
lmult0 \fs18\cf0\par\pard\li1920\ri0\sl-213\slmult0 \fs18\cf0\par\pard\li1920\ri
0\sl-693\slmult0 \fs46\cf0\f0\charscalex100\b {The Relationship Between Fair Val
ues}\b0 \par\pard\li1880\ri0\sl-533\slmult0 \fs46\cf0\f0\charscalex100\b {in Ban
ks\uc1\u8217X Trading Books and Volatility}\b0 \par\pard\li3373\ri0\sl-533\slmul
t0 \fs46\cf0\f0\charscalex100\b {in Share Price Returns}\b0 \par\pard\li3373\ri0
\sl-533\slmult0 \fs46\cf0\f0\charscalex100\b {in the Indian Context}\b0 \fs26\cf
0\f0\charscalex100\b {\uc1\u8224X}\b0 \par\pard\li7213\ri0\sl-320\slmult0 \fs22\
cf0\f0\charscalex100\b \i {Tanupa Chakraborty*}\b0 \i0 \par\pard\li1906\ri0\sl-2
13\slmult0 \fs18\cf0\par\pard\li1906\ri0\sl-346\slmult0 \fs18\cf0\f0\charscalex1
00\i {\uc1\u8216XFair value\uc1\u8217X of an asset or a liability refers to
the amount at which such an asset could be}\i0 \par\pard\li1906\ri0\sl-253
\slmult0 \fs18\cf0\f0\charscalex100\i {exchanged, or the liability settled, bet
ween knowledgeable, willing parties, in an arm\uc1\u8217Xs length}\i0 \par\pard
\li1906\ri0\sl-253\slmult0 \fs18\cf0\f0\charscalex100\i {transaction. Although
the growing irrelevance of historical cost-based accounting numbers}\i0 \par
\pard\li1906\ri0\sl-253\slmult0 \fs18\cf0\f0\charscalex100\i {in the financial
statements, in the wake of developments in financial markets and}\i0 \par\par
d\li1906\ri0\sl-253\slmult0 \fs18\cf0\f0\charscalex100\i {advancements in techn
ology, has triggered off the debate on fair value accounting a decade}\i0 \p
ar\pard\li1906\ri0\sl-240\slmult0 \fs18\cf0\f0\charscalex100\i {and a half ago,
some issues still stand in the way of extensive application of fair valu
e}\i0 \par\pard\li1906\ri0\sl-253\slmult0 \fs18\cf0\f0\charscalex100\i {accounti
ng framework. One such issue is the excessive level of volatility in the fi
nancial}\i0 \par\pard\li1906\ri0\sl-253\slmult0 \fs18\cf0\f0\charscalex100\i {st
atements induced by fair valuations and its resultant impact on the flight
of capital from}\i0 \par\pard\li1906\ri0\sl-253\slmult0 \fs18\cf0\f0\charscalex1
00\i {the firm\uc1\u8217Xs equity. In accordance with the series of guidelin
es issued by the Reserve Bank}\i0 \par\pard\li1906\ri0\sl-240\slmult0 \fs18\cf
0\f0\charscalex100\i {of India between 1995-2000, fair value accounting has be
en applied only on the \uc1\u8216Xheld for}\i0 \par\pard\li1906\ri0\sl-253\sl
mult0 \fs18\cf0\f0\charscalex100\i {trading\uc1\u8217X securities in banks\uc1\u
8217X investment portfolio in India till today. Accordingly, this research}
\i0 \par\pard\li1906\ri0\sl-253\slmult0 \fs18\cf0\f0\charscalex100\i {paper mak
es a modest attempt to examine whether fair valuations in banks\uc1\u8217X t
rading books}\i0 \par\pard\li1906\ri0\sl-240\slmult0 \fs18\cf0\f0\charscalex100\
i {bring about an increased volatility in banks\uc1\u8217X stock returns over
the time period 1994-1995}\i0 \par\pard\li1906\ri0\sl-253\slmult0 \fs18\cf0\f0
\charscalex100\i {to 2007-2008, using a sample of Indian banks and bank inde
x, i.e., BSE BANKEX, and}\i0 \par\pard\li1906\ri0\sl-253\slmult0 \fs18\cf0\f0\ch
arscalex100\i {autoregressive and multiple linear regression techniques.}\i0
\par\pard\li1626\ri0\sl-213\slmult0 \fs18\cf0\par\pard\li1626\ri0\sl-440\slmult0
\fs26\cf0\f0\charscalex100\b {Introduction}\b0 \par\pard\li1626\ri0\sl-333\slmu

lt0 \fs20\cf0\f0\charscalex100 {Financial statements, the primary output in an a

ccounting information system, enables a firm\uc1\u8217Xs}\par\pard\li1626\ri0\sl
-266\slmult0 \fs18\cf0\f0\charscalex100 {stakeholders, whether acting in the cap
acity of investors, creditors, lenders, suppliers, customers,}\par\pard\li1626\r
i0\sl-266\slmult0 \fs20\cf0\f0\charscalex100 {government or members of the socie
ty in general, to focus the lens on the state of affairs of a}\par\pard\li1626\r
i0\sl-266\slmult0 \fs18\cf0\f0\charscalex100 {business. It is widely acknowledge
d in both academic literature and regulatory debate that the}\par\pard\li1626\ri
0\sl-280\slmult0 \fs18\cf0\f0\charscalex100 {discipline enforced by generally ac
cepted accounting principles in modeling, preparing and}\par\pard\li1626\ri0\sl266\slmult0 \fs20\cf0\f0\charscalex100 {presenting financial statements should h
elp in reducing the information asymmetry between}\par\pard\li1626\ri0\sl-266\sl
mult0 \fs20\cf0\f0\charscalex100 {the firm\uc1\u8217Xs decision makers, i.e., ma
nagement and the stakeholders with a view to facilitating}\par\pard\li1626\ri0\s
l-266\slmult0 \fs20\cf0\f0\charscalex100 {a timely and proper decision making by
the stakeholders. But in today\uc1\u8217Xs business environment}\par\pard\li162
6\ri0\sl-280\slmult0 \fs20\cf0\f0\charscalex100 {marked by innovations in financ
ial products and services offered by financial institutions,}\par\pard\li1626\ri
0\sl-266\slmult0 \fs20\cf0\f0\charscalex100 {development of secondary markets
for instruments that were considered illiquid and}\par\pard\li1626\ri0\sl-26
6\slmult0 \fs18\cf0\f0\charscalex100 {non-tradable until recently and increasing
use of risk transfer mechanisms such as securitization}\par\pard\li1626\ri0\sl266\slmult0 \fs20\cf0\f0\charscalex100 {and derivatives contracts, historical co
st accounting model that currently prevails across the}\par\pard\li1626\ri0\sl-3
73\slmult0 \fs16\cf0\f0\charscalex100 {\uc1\u8224X The facts and findings of th
is paper have been presented at the 9}\fs10\cf0\f0\charscalex100 {th}\fs16\cf0\
f0\charscalex100 { International Accounting Conference}\par\pard\li1853\ri0\sl200\slmult0 \fs16\cf0\f0\charscalex100 {organized by the Indian Accounting Assoc
iation Research Foundation (IAARF) in association with Delloitte, at}\par\pard\l
i1853\ri0\sl-186\slmult0 \fs16\cf0\f0\charscalex100 {Science City, Kolkata, in J
anuary 2009.}\par\pard\li1626\ri0\sl-346\slmult0 \fs12\cf0\f0\charscalex100 {* S
enior Lecturer, Department of Commerce, University of Calcutta, Kolkata, India.
E-mail: tanupachakraborty@gmail.com}\par\pard\sect\sectd\sbknone\cols2\colno1\co
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il to reflect the current values of assets and liabilities and}\par\pard\li1626\
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he asset quality is normally taken into account by way of creating}\par\pard\li1
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ainst income statement, though such charges are not aligned with}\par\pard\li162
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degree of deterioration of the asset as perceived by the market.}\par\pard\li162
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ial statements keep innovative financial products such as derivatives}\par\pard\
li1626\ri0\sl-266\slmult0 \fs20\cf0\f0\charscalex100 {off-balance sheet. Such cr
iticisms of historical cost-based statements have sparked off debate}\par\pard\l
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ar\pard\li1906\ri0\sl-386\slmult0 \fs20\cf0\f0\charscalex100 {As defined by Inte
rnational Accounting Standards Board (IASB), \uc1\u8216Xfair value\uc1\u8217X of
an asset or}\par\pard\li1626\ri0\sl-266\slmult0 \fs20\cf0\f0\charscalex100 {a l
iability is the amount for which such asset could be exchanged, or the liability
settled,}\par\pard\li1626\ri0\sl-266\slmult0 \fs18\cf0\f0\charscalex100 {betwee
n knowledgeable, willing parties in an arm\uc1\u8217Xs length transaction. Impli
cit in this definition}\par\pard\li1626\ri0\sl-266\slmult0 \fs20\cf0\f0\charscal
ex100 {is the notion that fair value seeks to capture the value of an asset or a
liability to any entity by}\par\pard\li1626\ri0\sl-280\slmult0 \fs18\cf0\f0\cha
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alex100 {actual transaction or an active market for that asset or liability. Acc
ordingly, quoted market}\par\pard\li1626\ri0\sl-266\slmult0 \fs18\cf0\f0\charsca
lex100 {price for an identical asset or a liability in an active reference marke
t is the best evidence of fair}\par\pard\li1626\ri0\sl-266\slmult0 \fs18\cf0\f0\
charscalex100 {value and hence is used as the basis of valuation under fair valu
e accounting. However, where}\par\pard\li1626\ri0\sl-280\slmult0 \fs18\cf0\f0\ch
arscalex100 {active markets for assets or liabilities are unavailable, quoted ma
rket price of similar or related}\par\pard\li1626\ri0\sl-266\slmult0 \fs18\cf0\f
0\charscalex100 {asset or liability, adjusted objectively to account for the dif
ferences between the traded instrument}\par\pard\li1626\ri0\sl-266\slmult0 \fs20
\cf0\f0\charscalex100 {and the valued item\uc1\u8217Xs specific characteristics,
is regarded as a fair value estimate. If the fair}\par\pard\li1626\ri0\sl-266\s
lmult0 \fs18\cf0\f0\charscalex100 {value of an asset or a liability cannot be de
termined in any one of the above two ways, the firm}\par\pard\li1626\ri0\sl-280\
slmult0 \fs20\cf0\f0\charscalex100 {may make use of an appropriate valuation mod
el, such as binomial option pricing models or}\par\pard\li1626\ri0\sl-266\slmult
0 \fs20\cf0\f0\charscalex100 {discounted cash flow method, etc. to arrive at an
estimate of fair value. Thus, under fair value}\par\pard\li1626\ri0\sl-266\slmul
t0 \fs20\cf0\f0\charscalex100 {accounting, all assets and liabilities are to be
carried on the balance sheet at their fair values}\par\pard\li1626\ri0\sl-266\sl
mult0 \fs18\cf0\f0\charscalex100 {measured in accordance with any one of the thr
ee bases as discussed above, and any change in}\par\pard\li1626\ri0\sl-280\slmul
t0 \fs20\cf0\f0\charscalex100 {fair value between beginning and end period to be
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0\cf0\f0\charscalex100 {A major advantage with fair value accounting is that it
permits a timely recognition of any}\par\pard\li1626\ri0\sl-266\slmult0 \fs20\cf
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efits expected to be}\par\pard\li1626\ri0\sl-280\slmult0 \fs20\cf0\f0\charscalex
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no impact on the}\par\pard\li1626\ri0\sl-266\slmult0 \fs20\cf0\f0\charscalex100
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in asset value,}\par\pard\li1626\ri0\sl-266\slmult0 \fs18\cf0\f0\charscalex100
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ld the balance}\par\pard\li1626\ri0\sl-266\slmult0 \fs20\cf0\f0\charscalex100 {s
heet from revealing such deterioration because a significant increase in provisi
ons and charge-}\par\pard\li1626\ri0\sl-280\slmult0 \fs20\cf0\f0\charscalex100 {
offs to take account of a substantial asset devaluation may come as a big surpri
se to the}\par\pard\li1626\ri0\sl-266\slmult0 \fs18\cf0\f0\charscalex100 {stakeh
olders and drive them to overreact to such news. As, for example, a bank may dec
ide to}\par\pard\sect\sectd\sbknone\pgwsxn12240\pghsxn15840\marglsxn666\margrsxn
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0\f0\charscalex100 {The IUP Journal of Accounting Research & Audit Practices, Vo

l. IX, Nos. 1 & 2, 2010}\par\pard\sect\sectd\sbknone\pgwsxn12240\pghsxn15840\mar

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26\ri0\sl-213\slmult0 \fs18\cf0\par\pard\li1626\ri0\sl-213\slmult0 \fs18\cf0\par
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lmult0 \fs20\cf0\f0\charscalex100 {sell off its investments, when the value of i
ts investment portfolio has appreciated significantly,}\par\pard\li1626\ri0\sl-2
66\slmult0 \fs18\cf0\f0\charscalex100 {and utilize the profits, so earned, to se
t off and limit the losses caused by deterioration in its}\par\pard\li1626\ri0\s

l-266\slmult0 \fs20\cf0\f0\charscalex100 {loan portfolio. In fair value accounti

ng, such a strategy cannot be adopted because the profits}\par\pard\li1626\ri0\s
l-266\slmult0 \fs20\cf0\f0\charscalex100 {resulting from appreciation of the inv
estment portfolio are recognized in income statement}\par\pard\li1626\ri0\sl-280
\slmult0 \fs20\cf0\f0\charscalex100 {much earlier at the time of its occurrence
rather than at the time of disposal of investments.}\par\pard\li1626\ri0\sl-266\
slmult0 \fs20\cf0\f0\charscalex100 {Furthermore, the problem of valuation of der
ivatives instruments under historical cost-based}\par\pard\li1626\ri0\sl-266\slm
ult0 \fs18\cf0\f0\charscalex100 {accounting system has kept such instruments off
the balance sheet. An increasing reliance on}\par\pard\li1626\ri0\sl-266\slmult
0 \fs18\cf0\f0\charscalex100 {fair value measurement is expected to pave the way
for financial statements properly accounting}\par\pard\li1626\ri0\sl-280\slmult
0 \fs20\cf0\f0\charscalex100 {for derivatives transactions, thereby amending a m
ajor element of opaqueness in the present}\par\pard\li1626\ri0\sl-266\slmult0 \f
s20\cf0\f0\charscalex100 {accounting and reporting system.}\par\pard\li1906\ri0\
sl-386\slmult0 \fs20\cf0\f0\charscalex100 {Despite the advantage of providing mo
re relevant information to the stakeholders in}\par\pard\li1626\ri0\sl-266\slmul
t0 \fs20\cf0\f0\charscalex100 {comparison to that of current historical cost-bas
ed accounting, there are still some issues}\par\pard\li1626\ri0\sl-266\slmult0 \
fs18\cf0\f0\charscalex100 {which have made the debate on fair value accounting v
ery contentious. When market values}\par\pard\li1626\ri0\sl-266\slmult0 \fs20\cf
0\f0\charscalex100 {are not observable, fair values of assets or liabilities are
closely approximated by the use of}\par\pard\li1626\ri0\sl-280\slmult0 \fs20\cf
0\f0\charscalex100 {valuation models. Since a wide variety of valuation methods
are available, with each having}\par\pard\li1626\ri0\sl-266\slmult0 \fs18\cf0\f0
\charscalex100 {its own set off assumptions, estimates, data inputs and measurem
ent methodology, and as the}\par\pard\li1626\ri0\sl-266\slmult0 \fs20\cf0\f0\cha
rscalex100 {valuation done for a particular purpose at a particular date may not
be appropriate for other}\par\pard\li1626\ri0\sl-266\slmult0 \fs20\cf0\f0\chars
calex100 {purposes or other dates, all non-market-based fair values tend to be h
ighly subjective and}\par\pard\li1626\ri0\sl-280\slmult0 \fs20\cf0\f0\charscalex
100 {hence unreliable. Not only are fair value measures of illiquid assets diffi
cult to determine,}\par\pard\li1626\ri0\sl-266\slmult0 \fs20\cf0\f0\charscalex10
0 {verify and audit, an indiscriminate use of valuation models across balance-sh
eet items and}\par\pard\li1626\ri0\sl-266\slmult0 \fs20\cf0\f0\charscalex100 {ac
ross firms and countries may also make them less comparable. Moreover, such subj
ectivity}\par\pard\li1626\ri0\sl-266\slmult0 \fs18\cf0\f0\charscalex100 {in fair
value measurements provides the management with an opportunity to manipulate th
e}\par\pard\li1626\ri0\sl-280\slmult0 \fs20\cf0\f0\charscalex100 {bottom-line an
d alter the various financial ratios in order to paint a rosy picture of the sta
te of}\par\pard\li1626\ri0\sl-266\slmult0 \fs20\cf0\f0\charscalex100 {affairs of
the business. Again, marking down a firm\uc1\u8217Xs financial liabilities to f
air values and}\par\pard\li1626\ri0\sl-266\slmult0 \fs18\cf0\f0\charscalex100 {r
ecording it as a gain in the income statement in the event of the firm\uc1\u8217
Xs own credit deterioration}\par\pard\li1626\ri0\sl-266\slmult0 \fs18\cf0\f0\cha
rscalex100 {may result in an insolvent firm appear solvent. Even if the above-me
ntioned issues are resolved}\par\pard\li1626\ri0\sl-280\slmult0 \fs20\cf0\f0\cha
rscalex100 {by disallowing the fair valuation of the firm\uc1\u8217Xs own outsta
nding liabilities, and reaching a}\par\pard\li1626\ri0\sl-266\slmult0 \fs18\cf0\
f0\charscalex100 {consensus as regards the use of valuation models asset-wise an
d country-wise, the apprehension}\par\pard\li1626\ri0\sl-266\slmult0 \fs18\cf0\f
0\charscalex100 {that fair value will bring an excessive level of volatility to
the financial statements and hence}\par\pard\li1626\ri0\sl-266\slmult0 \fs20\cf0
\f0\charscalex100 {make the statements more difficult for the stakeholders, espe
cially the investors, to interpret}\par\pard\li1626\ri0\sl-280\slmult0 \fs20\cf0
\f0\charscalex100 {may still stand in the way of full endorsement of the fair va
lue accounting and reporting.}\par\pard\li1906\ri0\sl-373\slmult0 \fs20\cf0\f0\c
harscalex100 {It is primarily argued that today\uc1\u8217Xs business environment
, marked by rapid price changes}\par\pard\li1626\ri0\sl-280\slmult0 \fs18\cf0\f0
\charscalex100 {and shorter technology cycles, requires fair valuation to change

frequently in line with such}\par\pard\li1626\ri0\sl-266\slmult0 \fs18\cf0\f0\c

harscalex100 {developments and hence, this may induce considerable volatility in
income and capital measures.}\par\pard\li1626\ri0\sl-266\slmult0 \fs18\cf0\f0\c
harscalex100 {The reason why the issue of volatility in fair value measurement a
pproach is of utmost concern}\par\pard\li1626\ri0\sl-266\slmult0 \fs18\cf0\f0\ch
arscalex100 {to regulators, standard setters and firms, and warrants a separate
empirical examination is the}\par\pard\li1626\ri0\sl-280\slmult0 \fs18\cf0\f0\ch
arscalex100 {impact that such increased volatility of financial statements might
have on the existence of the}\par\pard\li1626\ri0\sl-266\slmult0 \fs20\cf0\f0\c
harscalex100 {firm altogether. It is often debated, in academic forums, that suc
h increased volatility in}\par\pard\li1626\ri0\sl-266\slmult0 \fs20\cf0\f0\chars
calex100 {accounting magnitudes brought about by fair value accounting would not
necessarily be a}\par\pard\li1626\ri0\sl-266\slmult0 \fs20\cf0\f0\charscalex100
{problem if shareholders correctly interpret such volatility and its possible s
ources and do not}\par\pard\li1626\ri0\sl-280\slmult0 \fs20\cf0\f0\charscalex100
{panic or get ecstatic and trade in the stock market. So, the research question
that this paper}\par\pard\li1626\ri0\sl-266\slmult0 \fs20\cf0\f0\charscalex100
{intends to empirically examine is whether volatility in fair value-based financ
ial statements}\par\pard\sect\sectd\sbknone\pgwsxn12240\pghsxn15840\marglsxn666\
margrsxn133\cols2\colno1\colw9080\colsr-0\colno2\colw2360\pard\li1626\ri0\sl-400
\slmult0 \fs16\cf0\f0\charscalex100 {The Relationship Between Fair Values in Ban
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ctd\sbknone\pgwsxn12240\pghsxn15840\marglsxn666\margrsxn133\pard\sect\sectd\sbkp
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lmult0 \fs20\cf0\f0\charscalex100 {bring about volatility in firm\uc1\u8217Xs sh
are price returns as well. There are two schools of thought on}\par\pard\li1626\
ri0\sl-266\slmult0 \fs20\cf0\f0\charscalex100 {this issue of volatility. Those w
ho argue that volatility in fair value accounting numbers also}\par\pard\li1626\
ri0\sl-266\slmult0 \fs18\cf0\f0\charscalex100 {cause volatility in share price r
eturns contend that shareholders may not properly interpret the}\par\pard\li1626
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ts induced by fair valuations and hence, trade frequently owing}\par\pard\li1626
\ri0\sl-280\slmult0 \fs20\cf0\f0\charscalex100 {to violent fluctuations of their
opinion thereby resulting into volatility in share price returns.}\par\pard\li1
626\ri0\sl-266\slmult0 \fs18\cf0\f0\charscalex100 {However, scholars holding a c
ontrary opinion argue that the increased volatility in fair value-}\par\pard\li1
626\ri0\sl-266\slmult0 \fs20\cf0\f0\charscalex100 {based financial statements wo
uld have no impact on shareholders\uc1\u8217X perceptions as institutional}\par\
pard\li1626\ri0\sl-266\slmult0 \fs20\cf0\f0\charscalex100 {investors and individ
ual investors, with the help of market analysts, always try to extrapolate}\par\
pard\li1626\ri0\sl-280\slmult0 \fs18\cf0\f0\charscalex100 {fair valuations from
a variety of information sources to base their investment decisions even in}\par
\pard\li1626\ri0\sl-266\slmult0 \fs20\cf0\f0\charscalex100 {the absence of fair
value-based numbers in the financial statements.}\par\pard\li1906\ri0\sl-386\slm
ult0 \fs20\cf0\f0\charscalex100 {Till date, the areas where fair value disclosur
e, measurement and recognition standards}\par\pard\li1626\ri0\sl-266\slmult0 \fs
20\cf0\f0\charscalex100 {have been issued by the standard setting bodies interna
tionally primarily relate to financial}\par\pard\li1626\ri0\sl-266\slmult0 \fs18
\cf0\f0\charscalex100 {instruments like debt and equity securities, derivatives
contracts, loans, deposits and employees}\par\pard\li1626\ri0\sl-266\slmult0 \fs
20\cf0\f0\charscalex100 {stock options, which are the principal components of a
bank\uc1\u8217Xs balance sheet. Besides, the}\par\pard\li1626\ri0\sl-280\slmult0
\fs20\cf0\f0\charscalex100 {concept of fair value has been used in the measurem
ent of goodwill, intangible assets and}\par\pard\li1626\ri0\sl-266\slmult0 \fs20
\cf0\f0\charscalex100 {other non-current assets held for sale within the realm o
f \uc1\u8216Ximpairment of assets\uc1\u8217X. India is not}\par\pard\li1626\ri0\
sl-266\slmult0 \fs20\cf0\f0\charscalex100 {an exception in this regard. Although
it is only recently that the Institute of Chartered}\par\pard\li1626\ri0\sl-266
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h two new accounting standards 30 and 31}\par\pard\li1626\ri0\sl-280\slmult0 \fs
18\cf0\f0\charscalex100 {dealing with recognition, measurement and presentation
of financial instruments based on fair}\par\pard\li1626\ri0\sl-266\slmult0 \fs20
\cf0\f0\charscalex100 {values (effective for all forms of companies from April 1
, 2009), the Reserve Bank of India}\par\pard\li1626\ri0\sl-266\slmult0 \fs20\cf0

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8217X investment portfolio since 2000-}\par\pard\li1626\ri0\sl-266\slmult0 \fs18
\cf0\f0\charscalex100 {2001. Like in most international countries, the RBI has b
een requiring the Indian banks to hold}\par\pard\li1626\ri0\sl-280\slmult0 \fs20
\cf0\f0\charscalex100 {securities in their investment portfolio under two or thr
ee broad categories\uc1\u8212Xtrading or current}\par\pard\li1626\ri0\sl-266\slm
ult0 \fs18\cf0\f0\charscalex100 {investment category, investment or held to matu
rity or permanent category and, available for}\par\pard\li1626\ri0\sl-266\slmult
0 \fs18\cf0\f0\charscalex100 {sale category (optional)\uc1\u8212Xdepending on th
e intended period and purpose of holding the securities.}\par\pard\li1626\ri0\sl
-266\slmult0 \fs18\cf0\f0\charscalex100 {The RBI mandates a monthly disclosure o
f fair values for securities held for trading purposes as}\par\pard\li1626\ri0\s
l-280\slmult0 \fs18\cf0\f0\charscalex100 {these are to be marked to market on a
monthly basis and any change in their fair values should}\par\pard\li1626\ri0\sl
-266\slmult0 \fs20\cf0\f0\charscalex100 {be adjusted as profit or loss in the in
come statement. The permanent category comprises}\par\pard\li1626\ri0\sl-266\slm
ult0 \fs20\cf0\f0\charscalex100 {securities acquired by the banks with the inten
tion of holding them till maturity, and hence}\par\pard\li1626\ri0\sl-266\slmult
0 \fs20\cf0\f0\charscalex100 {are not to be marked to market but should be value
d year end at acquisition cost less any}\par\pard\li1626\ri0\sl-280\slmult0 \fs2
0\cf0\f0\charscalex100 {amount written off in income statement, to reflect dimin
ution in value or amortization of}\par\pard\li1626\ri0\sl-266\slmult0 \fs20\cf0\
f0\charscalex100 {premium amount paid over face value. Available for sale catego
ry includes those securities}\par\pard\li1626\ri0\sl-266\slmult0 \fs20\cf0\f0\ch
arscalex100 {which are neither traded frequently nor held till maturity but can
be sold in response to}\par\pard\li1626\ri0\sl-266\slmult0 \fs20\cf0\f0\charscal
ex100 {anticipation of changes in interest rates, etc. Such securities should be
carried in the balance}\par\pard\li1626\ri0\sl-280\slmult0 \fs20\cf0\f0\charsca
lex100 {sheet at their fair values estimated by drawing reference to the best av
ailable source of current}\par\pard\li1626\ri0\sl-266\slmult0 \fs18\cf0\f0\chars
calex100 {market quotations or other data relative to current values issued by r
egulatory agencies, and}\par\pard\li1626\ri0\sl-266\slmult0 \fs18\cf0\f0\charsca
lex100 {any depreciation (only) in their fair values are to be recognized year e
nd by way of adjustments}\par\pard\li1626\ri0\sl-266\slmult0 \fs20\cf0\f0\charsc
alex100 {between income statement and investment fluctuation reserve account. Ho
wever, unlike in}\par\pard\li1626\ri0\sl-280\slmult0 \fs20\cf0\f0\charscalex100
{international countries, the RBI has prescribed the percentage holdings in each
category of a}\par\pard\li1626\ri0\sl-266\slmult0 \fs20\cf0\f0\charscalex100 {b
ank\uc1\u8217Xs investment portfolio. By way of issuing a series of guidelines o
n classification and}\par\pard\li1626\ri0\sl-266\slmult0 \fs20\cf0\f0\charscalex
100 {valuation of investments, the RBI has gradually changed the percentage patt
ern of holdings}\par\pard\li1626\ri0\sl-266\slmult0 \fs20\cf0\f0\charscalex100 {
from 70% in \uc1\u8216Xpermanent\uc1\u8217X category and 30% in current or tradi
ng category in 1992-1993 to}\par\pard\sect\sectd\sbknone\pgwsxn12240\pghsxn15840
\marglsxn666\margrsxn133\cols2\colno1\colw3400\colsr-0\colno2\colw8040\pard\li16
26\ri0\sl-213\slmult0 \fs18\cf0\par\pard\li1626\ri0\sl-306\slmult0 \fs16\cf0\f0\
charscalex100 {66}\par\column\pard\li0\ri0\sl-213\slmult0 \fs18\cf0\par\pard\li0
\ri0\sl-306\slmult0 \fs16\cf0\f0\charscalex100 {The IUP Journal of Accounting Re
search & Audit Practices, Vol. IX, Nos. 1 & 2, 2010}\par\pard\sect\sectd\sbknone
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7X, i.e., permanent portion of total investments to only 25% in 2000-}\par\pard\
li1626\ri0\sl-266\slmult0 \fs18\cf0\f0\charscalex100 {2001. Thus, the above disc
ussion suggests that at present, the research on volatility in fair}\par\pard\li
1626\ri0\sl-266\slmult0 \fs18\cf0\f0\charscalex100 {value accounting can be done
with reference to banking sector alone, given the standards or}\par\pard\li1626
\ri0\sl-266\slmult0 \fs18\cf0\f0\charscalex100 {regulations on fair value accoun
ting and reporting prevailing nationally and internationally.}\par\pard\li1626\r
i0\sl-280\slmult0 \fs20\cf0\f0\charscalex100 {The above-mentioned accounting tre
atment indicates that the change in valuation of securities}\par\pard\li1626\ri0
\sl-266\slmult0 \fs20\cf0\f0\charscalex100 {held in the Indian banks\uc1\u8217X
trading book (i.e., current or trading investment category) from}\par\pard\li162
6\ri0\sl-266\slmult0 \fs20\cf0\f0\charscalex100 {current accounting to fair valu
e accounting must have increased volatility in banks\uc1\u8217X income}\par\pard
\li1626\ri0\sl-266\slmult0 \fs18\cf0\f0\charscalex100 {and capital significantly
and this, in turn, casts a doubt on the shareholders ability to correctly}\par\

pard\li1626\ri0\sl-280\slmult0 \fs20\cf0\f0\charscalex100 {interpret such volati

lity and make no impact on banks\uc1\u8217X equity return volatility. Accordingl
y,}\par\pard\li1626\ri0\sl-266\slmult0 \fs18\cf0\f0\charscalex100 {this research
paper focuses on Indian banks\uc1\u8217X trading books to examine empirically t
he volatility}\par\pard\li1626\ri0\sl-266\slmult0 \fs20\cf0\f0\charscalex100 {ef
fect of fair value measurements on banks\uc1\u8217X share price returns.}\par\pa
rd\li1906\ri0\sl-386\slmult0 \fs20\cf0\f0\charscalex100 {The paper reviews the a
vailable literature on the research subject and outlines the objective}\par\pard
\li1626\ri0\sl-266\slmult0 \fs20\cf0\f0\charscalex100 {and hypothesis of the stu
dy. It also presents the sample selection and research methodology,}\par\pard\li
1626\ri0\sl-266\slmult0 \fs20\cf0\f0\charscalex100 {enumerates the findings of t
he study followed by conclusion.}\par\pard\li1626\ri0\sl-213\slmult0 \fs18\cf0\p
ar\pard\li1626\ri0\sl-320\slmult0 \fs26\cf0\f0\charscalex100\b {Literature Revie
w}\b0 \par\pard\li1626\ri0\sl-333\slmult0 \fs20\cf0\f0\charscalex100 {Internatio
nally, several research studies have argued the case for conceptual desirability
of fair}\par\pard\li1626\ri0\sl-280\slmult0 \fs18\cf0\f0\charscalex100 {value m
easurement, notably on the \uc1\u8216Xvalue relevance\uc1\u8217X dimension, and
explored empirically the}\par\pard\li1626\ri0\sl-280\slmult0 \fs18\cf0\f0\charsc
alex100 {value relevance of investment securities\uc1\u8217X fair values disclos
ed by the banks after issuance of an}\par\pard\li1626\ri0\sl-280\slmult0 \fs20\c
f0\f0\charscalex100 {accounting standard mandating such recognition by way of ex
amining the incremental}\par\pard\li1626\ri0\sl-266\slmult0 \fs18\cf0\f0\charsca
lex100 {association of such a change with banks\uc1\u8217X share prices or share
returns after controlling for other}\par\pard\li1626\ri0\sl-280\slmult0 \fs20\c
f0\f0\charscalex100 {market information. In his exploratory study, Hitz (2007) h
as justified the decision relevance}\par\pard\li1626\ri0\sl-266\slmult0 \fs18\cf
0\f0\charscalex100 {of fair value measurement from both valuation and informatio
n perspectives, but has contended}\par\pard\li1626\ri0\sl-280\slmult0 \fs20\cf0\
f0\charscalex100 {that the theoretical reasoning that underlies the standard set
ters\uc1\u8217X and regulators\uc1\u8217X endorsement}\par\pard\li1626\ri0\sl-28
0\slmult0 \fs18\cf0\f0\charscalex100 {of fair value measurement is inadequate an
d restricted in its validity and applicability. According}\par\pard\li1626\ri0\s
l-280\slmult0 \fs18\cf0\f0\charscalex100 {to Reuters (2008), proponents of fair
value accounting assert that it reveals economic realities}\par\pard\li1626\ri0\
sl-266\slmult0 \fs18\cf0\f0\charscalex100 {which were hidden by previous account
ing methods while its critics argue that the volatility in}\par\pard\li1626\ri0\
sl-280\slmult0 \fs20\cf0\f0\charscalex100 {financial information induced by fair
value accounting reduces stock prices and takes the}\par\pard\li1626\ri0\sl-280
\slmult0 \fs20\cf0\f0\charscalex100 {investors by surprise. In the light of comm
ents made by the chiefs of Securities and Exchange}\par\pard\li1626\ri0\sl-280\s
lmult0 \fs18\cf0\f0\charscalex100 {Commission (SEC), Federal Deposit Insurance C
orporation, and financial advisory firm Duff &}\par\pard\li1626\ri0\sl-266\slmul
t0 \fs20\cf0\f0\charscalex100 {Phelps in a roundtable discussion organized by SE
C on mark-to-market bookkeeping of firms\uc1\u8217X}\par\pard\li1626\ri0\sl-280\
slmult0 \fs20\cf0\f0\charscalex100 {investment portfolio, Barr (2008) has opined
that, though some changes are needed, mark-to-}\par\pard\li1626\ri0\sl-266\slmu
lt0 \fs20\cf0\f0\charscalex100 {market (i.e. fair value) accounting does a fair
job of assessing a company\uc1\u8217Xs financial health.}\par\pard\li1906\ri0\sl
-400\slmult0 \fs20\cf0\f0\charscalex100 {Among the empirical research on book ve
rsus fair value accounting of banks\uc1\u8217X investment}\par\pard\li1626\ri0\s
l-266\slmult0 \fs20\cf0\f0\charscalex100 {portfolio, a few noted ones are men
tioned below. Using a sample of the US banks,}\par\pard\li1626\ri0\sl-266\slmu
lt0 \fs20\cf0\f0\charscalex100 {Barth (1994) has found that investment securitie
s\uc1\u8217X fair values are incrementally associated}\par\pard\li1626\ri0\sl-26
6\slmult0 \fs20\cf0\f0\charscalex100 {with bank share prices after controlling f
or investment securities\uc1\u8217X book values. On the contrary,}\par\pard\li16
26\ri0\sl-280\slmult0 \fs20\cf0\f0\charscalex100 {Barth}{ }\fs20\cf0\f0\charscal
ex100\i {et al.}\i0 \fs20\cf0\f0\charscalex100 { (1995), using essentially the s
ame database, have found that such incremental}\par\pard\li1626\ri0\sl-266\slmul
t0 \fs18\cf0\f0\charscalex100 {volatility in fair value-based numbers is not ref

lected in bank share prices. Again, using similar}\par\pard\li1626\ri0\sl-266\sl

mult0 \fs20\cf0\f0\charscalex100 {approaches to assess the incremental value rel
evance of fair values of principal categories of}\par\pard\li1626\ri0\sl-266\slm
ult0 \fs20\cf0\f0\charscalex100 {the US banks\uc1\u8217X assets and liabilities
such as investment securities, loans, deposits and long-}\par\pard\sect\sectd\sb
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\sl-306\slmult0 \fs16\cf0\f0\charscalex100 {The Relationship Between Fair Values
in Banks\uc1\u8217X Trading Books and Volatility}\par\pard\li1626\ri0\sl-200\sl
mult0 \fs16\cf0\f0\charscalex100 {in Share Price Returns in the Indian Context}\
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\fs16\cf0\f0\charscalex100 {67}\par}