What are Observable Inputs?

Observable inputs are used to develop fair values for assets and liabilities, and are derived from market information. These inputs reflect the pricing assumptions that third parties would use when setting prices for assets and liabilities. Ideally, the valuation chosen should maximize the use of relevant observable inputs and minimize the use of unobservable inputs. By avoiding unobservable inputs, you can derive fair values that are more justifiable to auditors.

Examples of Observable Inputs

Examples of markets that are considered to provide observable inputs are noted below:

Stock exchanges. Stock exchanges, such as the New York Stock Exchange or NASDAQ, are centralized markets where publicly traded securities are bought and sold. Prices are transparent and continuously updated, based on the interaction of numerous buyers and sellers, making them a reliable source of observable market inputs.
Dealer markets. In dealer markets, financial instruments are traded through dealers who hold an inventory and quote prices at which they are willing to buy or sell. These markets, such as the corporate bond or foreign exchange markets, provide observable inputs through the bid-ask spreads and transaction volumes quoted by multiple competing dealers.
Brokered markets. Brokered markets involve intermediaries (brokers) who connect buyers and sellers, often in less liquid or specialized asset classes like real estate or large block equity trades. Although not as transparent as stock exchanges, brokers facilitate price discovery by gathering and sharing information from multiple parties, which helps create observable pricing inputs.

Since they involve large numbers of buyers and sellers.