Landmarks in XVA
First published:
ISBN: 9781782722939
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The FVA Debate: Reloaded
Massimo Morini
The FVA Debate: Reloaded
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 FVA debate arose in 2012 when Hull and White wrote two papers (Hull and White 2012a,b) in which they made essentially three claims.
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When a bank funds a derivative transaction at a cost higher than the risk-free rate, this extra funding cost is due to the bank’s risk of default, and it is perfectly compensated by the benefit of the debt value adjustment (DVA) of the funding transaction, called DVA2. If a dealer takes into account DVA2, there is no extra funding cost for the counterparty of the derivative transaction in the form of a funding cost adjustment (FCA).
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The DVA of the funding strategy (ie, DVA2) is a benefit to shareholders, so it should be taken into account by banks. Therefore, there is no FCA to be accounted for.
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In any case, any new derivative transaction modifies the riskiness of a company – and this is recognised by the market, which will charge the bank just the riskiness of this new transaction, not the pre-transaction bank funding cost. Thus, if, for example, a bank enters a transaction that is risk-free, it will be able to fund this transaction at the risk-free rate, so that, even neglecting the value of DVA2, there is no
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