Valuation uncertainty

IVSC is currently analyzing how uncertainty can be identified in the evaluation, how it can be explained and presented in a way that is useful for the valuation reports users.

The purpose is to assist professional valuers in providing appropriate information on factors that may have led to a significant uncertainty in estimated valuation.

Uncertainty definition according to IVSC: The possibility that the estimated value may differ from the price that could be obtained in a transfer of the same asset or liability taking place at the same time under the same terms and within the same market environment.

The effect of limiting conditions or restrictions that affect the investigations undertaken in preparing a valuation estimate are outside the definition of valuation uncertainty in this TIP, but should be separately disclosed under IVS 103 Reporting.

Causes of Uncertainty:

  • Market Uncertainty
  • Model Uncertainty
  • Input Uncertainty

Model and input uncertainty arise from the valuation process, are closely related and may be measureable. Market uncertainty arises because of events external from the valuation process and is not normally measureable.

Market Uncertainty

Market uncertainty arises when a market is disrupted at the valuation date by current or very recent events such as sudden economic or political crises.

Such events create valuation uncertainty, because the only inputs and metrics available for the valuation are likely to relate to the market before the event occurred and the impact of the event on prices will not be known until the market has stabilized.

Market uncertainty should not be confused with market risk. Market risk is the risk that an asset may lose value over time due to changes in market conditions that occur after the valuation date and usually it is something that is considered by market participants when negotiating a transaction and will be reflected in market prices.

                Model Uncertainty

Model uncertainty arises from characteristics of either the valuation model, or method, used.

For certain asset types, more than one method may be customarily used to estimate value. However, those models may not always produce the same outcome and therefore the selection of the most appropriate method may of itself be a source of uncertainty.

Model uncertainty can be measured by observing the effect on the valuation of using different models or methods.

                Input Uncertainty

Input uncertainty arises where there are a number of equally reasonable or feasible inputs or assumptions that can be used from the degree of veracity that can be attached to the data inputs used in the valuation and their impact on the outcome

Input uncertainty can be measured by the effect on the valuation of using reasonably possible alternative inputs.

In some situations the effect of input uncertainty may be ameliorated by the use of statistical sampling techniques to analyze and weight the range of available data before it is applied in the valuation model. However, input uncertainty can also arise where reduced liquidity or reduced market activity result in a reduction in the relevant data available to provide empirical support for valuations.

Materiality

IVS 103 Reporting second paragraph requires the valuation report to set out a clear and accurate description of any material uncertainty that directly affects the valuation.

 As indicated in the sixth paragraph most valuations contain an element of uncertainty but it is only to be disclosed when it is “material” and has a direct effect on the valuation.

It is therefore necessary to consider whether uncertainty is material. Materiality should be considered from two aspects:

  • whether the impact on the valuation figure is significant and
  • whether it is of concern to a user of the valuation having regard to the purpose for which it is required

Measuring Uncertainty

Model and input uncertainty may be measureable by observing the effect on the valuation of using either an alternative model or input.

The value of an asset is dependent upon the amount, timing and security of future cash flows between the counter parties. Variations in these mainly numeric inputs over a fixed time horizon are more readily measureable than those that might be involved in the valuation of other types of tangible or intangible assets held for an indefinite period, such as the comparative quality or utility of the asset or its potential for an alternative use.

Where the value of asset is uncertain because there is no market data available for an identical or similar instrument it is necessary to make an estimate of certain inputs into the valuation based on the assumptions that a market participant might make. In these circumstances it is more likely that two or more alternative figures that could be reasonably be chosen for a key input into the calculation.

Where this occurs it is recommended that the reported valuation is based on the most likely of these outcomes, but a sensitivity analysis is provided showing the effect of the range possible outcomes on the reported value.

Valuation Uncertainty – Exposure draft IVSC (PDF)

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