Differential pricing of discretionary, nondiscretionary and noise components of loan fair values=

Using a sample of banks, this study examines the capital market pricing implications of three components of loan fair values. We find that the nondiscretionary component is priced on a dollar-for-dollar basis, the discretionary component is assigned a significantly larger multiple than the nondiscretionary component and the noise component is not priced. This implies that the relevance and reliability of loan fair values differs across the three components. The larger multiple assigned to the discretionary component is predicted by a signaling motivation for discretionary behavior, consistent with the findings for allowance for loan losses. One cannot rule out the possibility that the estimated discretionary component is proxying for other value-relevant constructs that have a positive pricing implication. However, our results are robust to alternative specifications, including a levels and a changes formulation.