IFRS 13: What Certainty Equivalent Might be Requested when Deriving a Fair Value Based on Risk-Adjusted Expected Cash Flows?

The study raises the point to elicit thresholds for certainty equivalents when determining the fair value using Method 1of the present value techniques within the methodology of income approaches. Through applying the risk-measure Value at Risk as indicator for certainty equivalents, it becomes possible to utilise the experience gained from risk management practice. Based on the calculation of certainty equivalents (the risk-adjusted expected income and expenses) observable in AAA-, Baa- and high-yield-rated U.S. corporate bonds, the corresponding Values at Risk were assessed by modelling different probability distributions. The studies reveal that investors in U.S. corporate bonds had accepted certainty equivalents that approximately correspond to Values at Risk with a confidence level in the range between 50 and 75% when taking the yield premium as criterion. In risk management practice, Values at Risk with confidence levels of above 80% are recommended. However, the safety margins then to be demanded reach values of approx. 17-25% on the expected value, which is in drastic contrast to the historical certainty equivalent coefficients.