Value Relevance of the Fair Value Hierarchy of IFRS 7 in Europe. How reliable are mark-to-model Fair Values?

According to IFRS 7, banks have to disclose the inputs used in measuring the fair value of financial instruments. For this purpose the standard defines a three-level measurement hierarchy. The reliability of fair values is expected to decrease with decreasing hierarchy level due to the lower quality of the input factors. Using a value relevance research setting, I find that investors perceive the reliability of level 3 fair values as significantly lower than the reliability of level 1 fair values. However, in contrast to expectations, level 2 fair values are not perceived as less reliable. Thus, investors only doubt the reliability of fair values whose inputs are based on discretionary assumptions. Additionally, this paper analyses the impact of the reclassification of financial assets and of the regulatory capital ratio on the reliability of fair values. While I find a weakly significant impact of the regulatory capital ratio, the reclassification has in general no influence on the reliability of reported fair values.