Information, Market Behavior, and Valuation

Responding to the recent financial crisis, this paper examines the role of information flow and transparency in the maintenance of orderly markets. Information plays a role in markets at two different levels: securities trading activity and fundamental values. Efficiency in securities markets is seen to depend on the availability and free flow of information. Even given good trading information, however, sparse or inaccurate information on underlying values can contribute to the formation of asset bubbles. This leads to an informal model of a securitized asset value as a superposition of pure trading asset and pure underlying asset. The relative importance of these components depends on the state of information in the market.

Information on underlying values comes largely from financial accounting. We identify certain defects in going-concern accounting information not addressed—and perhaps aggravated—by fair value and mark-tomarket prescriptions. Valuation of liabilities is, and has always been, particularly problematic. Neither are going concern asset values that are the same as marking to market.

We adduce work by Wang and recent efforts of Madan and coworkers as possible conceptual tools for dealing with asset and liability valuation, concluding with an outline of a practical approach.

Keywords: Information, Financial crisis, Securities markets, Financial reform, Fair value accounting, Valuation.