Fair value - Definition and Overview

Definition

Fair value, also called fair price, is a concept used in finance and economics.

It is considered by supporters to be a rational and unbiased estimate of the potential market price of a good, a service, a financial asset, etc., taking into account such elements as, among others:

• its production / distribution costs,
• its usefulness (for goods and services)
• its financial return (for assets), or what economists call utility (return / risk balance)
• its rarity.

Fair value vs market price

There are two schools of thought about the relation between the market price and the fair value, at least as concerns financial assets:

• The efficient market hypothesis, asserting that, in a well organized and well informed market, the market price is equal or close to the fair value, as investors react immediately and adequately to any outside information
• Behavioral finance that states, on the contrary, that the market price diverges quite often and largely from the fair value, because of various collective cognitive or emotional biases affecting investors.