Fair Value Hierarchy Explainer
The fair value hierarchy groups valuation inputs by how observable they are in the market. Level 1 uses quoted prices for identical assets or liabilities in active markets. Level 2 relies on other observable inputs, such as comparable prices or yield curves. Level 3 uses significant unobservable inputs developed through models and assumptions.
The hierarchy ranks inputs, not the quality or risk of the asset itself. A holding is classified according to the lowest-level input that is significant to the entire measurement. Transfers between levels can occur when market activity, pricing sources, or the significance of assumptions changes.
Level 1 values are usually straightforward but still require confirming the market is active and accessible. Level 2 measurements may use adjustments and pricing services. Level 3 can require discounted cash flow, option, or scenario models, with governance around data, assumptions, calibration, and independent review.
Investors should not read Level 3 as automatically wrong or Level 1 as permanently safe. The hierarchy signals estimation uncertainty and the type of evidence behind reported value. Useful analysis combines level disclosures with valuation techniques, sensitivities, unrealized gains and losses, liquidity, transfers, and reconciliation of Level 3 balances.
Level 1 is quoted, Level 2 is observable, and Level 3 is significantly unobservable.
The ranking concerns evidence, not asset quality.
One important Level 3 assumption can make the whole measurement Level 3.
Judgment is required.
Techniques, sensitivities, transfers, and reconciliations add context.
A level alone is not an investment conclusion.
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