`Fair value' of an asset or a liability refers to the amount at which such an asset could be exchanged, or the liability settled, between knowledgeable, willing parties, in an arm's length transaction. Although the growing irrelevance of historical cost-based accounting numbers in the financial statements, in the wake of developments in financial markets and advancements in technology, has triggered off the debate on fair value accounting a decade and a half ago, some issues still stand in the way of extensive application of fair value accounting framework. One such issue is the excessive level of volatility in the financial statements induced by fair valuations and its resultant impact on the flight of capital from the firm's equity. In accordance with the series of guidelines issued by the Reserve Bank of India between 1995-2000, fair value accounting has been applied only on the `held for trading' securities in banks' investment portfolio in India till today. Accordingly, this research paper makes a modest attempt to examine whether fair valuations in banks' trading books bring about an increased volatility in banks' stock returns over the time period 1994-1995 to 2007-2008, using a sample of Indian banks and bank index, i.e., BSE BANKEX, and autoregressive and multiple linear regression techniques.

Financial statements, the primary output in an accounting information system, enables a firm's stakeholders, whether acting in the capacity of investors, creditors, lenders, suppliers, customers, government or members of the society in general, to focus the lens on the state of affairs of a business. It is widely acknowledged in both academic literature and regulatory debate that the discipline enforced by generally accepted accounting principles in modeling, preparing and presenting financial statements should help in reducing the information asymmetry between the firm's decision makers, i.e., management and the stakeholders with a view to facilitating a timely and proper decision making by the stakeholders. But in today's business environment marked by innovations in financial products and services offered by financial institutions, development of secondary markets for instruments that were considered illiquid and non-tradable until recently and increasing use of risk transfer mechanisms such as securitization and derivatives contracts, historical cost accounting model that currently prevails across the world is often criticized on the ground that it is increasingly becoming inadequate in bridging the information gap between the firm's management and its stakeholders. The primary reason is that as assets, historical cost-based financial statements, are usually carried at the amount of consideration paid for its acquisition while liabilities are recorded on the amount received in exchange for the obligation, they fail to reflect the current values of assets and liabilities and hence are irrelevant to its users, i.e., the firm's stakeholders. Further, historical cost-based accounting system does not recognize appreciation in the value of an asset unless realized, whereas deterioration in the asset quality is normally taken into account by way of creating provisions and charge-offs against income statement, though such charges are not aligned with the year-to-year change in the degree of deterioration of the asset as perceived by the market. Besides, historical cost financial statements keep innovative financial products such as derivatives off-balance sheet. Such criticisms of historical cost-based statements have sparked off debate on `fair value accounting' with a view to improving the information content of financial statements.

Accounting Research and Audit Practices, Decision Maker, International Accounting Standards Board, IASB, Financial Ratios, Investment Decisions, Institute of Chartered Accountants of India, Reserve Bank of India, RBI, Securities and Exchange Commission, SEC, Investment Portfolio, Fair Value Measurements.