Implementing Fair Value Pricing

Abstract

Mutual fund transactions occur at the funds net asset value (NAV), typically computed at 4:00 p.m. Eastern time using closing prices for the day. For funds whose securities trade on a foreign exchange closing before the U.S. market, this convention can result in stale prices that can prompt short-term speculators to trade on information observed after the close of the foreign market to earn substantial profits at the expense of long-term shareholders. Fair value models, which suggest adjusting the closing prices of foreign securities according to information after the foreign market close, provide a solution to the mutual fund timing problem. Fair value pricing also lets mutual funds comply with regulation when significant events after foreign market closes result in stale closing prices. This article examines international equity fair value pricing, paying particular attention to model selection, empirical testing, and issues of implementation.