Unfair 'Fair Value' in Illiquid Markets : Excessive Spillover Effects in Times of Crisis

The paper investigates the effects of mark-to-market write-downs by financial institutions on market prices and volumes, as well as the prominent role that illiquidity plays in exacerbating the direct and spillover effects of exit valuation on equity and credit default swaps markets. Using a hand-collected database of write-down announcements made during and after the credit crisis (from January 1, 2007 through June 30, 2010), we find that firms that write down assets in accordance with mark-to-market rules experience significant abnormal negative stock returns and spikes in the premiums of credit default swaps written on their obligations. Equally noteworthy, we find that similar firms without write-downs exhibited sympathetic and significant negative abnormal returns and positive premiums at the same time as the write-down firms. We find that the effects of information spillovers associated with write-downs during the financial crisis go beyond normal information transfer expected from asset fundamentals and may have contributed to adverse consequences of the crisis