A significant credit risk adjustment may impact the overall classification of the measurement in the fair value hierarchy. This may be influenced by the type and source of data that is used to determine the credit risk adjustment. In determining whether the credit risk adjustment is observable, reporting entities need to consider what information is being used by market participants to price credit.

Different sources of information may be used to determine an adjustment for credit risk, including CDS rates, credit spreads, and historical default rates. CDS quotes and credit spreads may be either directly observable or derived from market observable data. However, reporting entities should use caution when obtaining a quote for a CDS or credit spread that is indirect (e.g., for a similar entity) or indicative. The quotes should be assessed to determine how closely they match the CDS price or credit spread for the actual asset or liability, and may require an adjustment to appropriately reflect market participant assumptions. Finally, historical default rates generally are not considered to be market-based given the lag in incorporating market trends.

For discussion of the fair value hierarchy, see FV 4.5.