DVA for Assets
Chris Kenyon and Richard Kenyon
DVA for Assets
Introduction
Preface to Chapter 1
Being Two-Faced over Counterparty Credit Risk
Risky Funding: A Unified Framework for Counterparty and Liquidity Charges
DVA for Assets
Pricing CDSs’ Capital Relief
The FVA Debate
The FVA Debate: Reloaded
Regulatory Costs Break Risk Neutrality
Risk Neutrality Stays
Regulatory Costs Remain
Funding beyond Discounting: Collateral Agreements and Derivatives Pricing
Cooking with Collateral
Options for Collateral Options
Partial Differential Equation Representations of Derivatives with Bilateral Counterparty Risk and Funding Costs
In the Balance
Funding Strategies, Funding Costs
The Funding Invariance Principle
Regulatory-Optimal Funding
Close-Out Convention Tensions
Funding, Collateral and Hedging: Arbitrage-Free Pricing with Credit, Collateral and Funding Costs
Bilateral Counterparty Risk with Application to Credit Default Swaps
KVA: Capital Valuation Adjustment by Replication
From FVA to KVA: Including Cost of Capital in Derivatives Pricing
Warehousing Credit Risk: Pricing, Capital and Tax
MVA by Replication and Regression
Smoking Adjoints: Fast Evaluation of Monte Carlo Greeks
Adjoint Greeks Made Easy
Bounding Wrong-Way Risk in Measuring Counterparty Risk
Wrong-Way Risk the Right Way: Accounting for Joint Defaults in CVA
Backward Induction for Future Values
A Non-Linear PDE for XVA by Forward Monte Carlo
Efficient XVA Management: Pricing, Hedging and Allocation
Accounting for KVA under IFRS 13
FVA Accounting, Risk Management and Collateral Trading
Derivatives Funding, Netting and Accounting
Managing XVA in the Ring-Fenced Bank
XVA: A Banking Supervisory Perspective
An Annotated Bibliography of XVA
The effect of own-default on the valuation of liabilities and derivatives through the debit valuation adjustment (DVA) has been widely discussed in the pricing literature (Burgard and Kjaer 2011; Brigo 2011; Cesari et al 2009; Pallavicini et al 2011; Crépey 2015). However, the effect of own-default on assets has yet to attract similar attention (Kenyon and Stamm (2012) being an exception), although it is clear that default will affect any asset that depends on company existence or performance.
We provide a hedging strategy for pricing DVA on assets extending Burgard and Kjaer (2011), and consider an example, so-called goodwill, in depth. We calibrate our model to seven US banks over the crisis period of mid-2007 to 2011 and show how their reported profits would have changed if DVA on this asset, as well as liabilities, had been included. This effect is highly significant for at least four of the seven banks.
Financial Accounting Standard 157 (FAS 157) requires US banks to reflect their own potential non-performance, which includes creditworthiness, in the fair value of their liabilities (Financial Accounting Standards Board 2010). However, creditworthiness has effects on
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