The Funding Invariance Principle
Youssef Elouerkhaoui
The Funding Invariance Principle
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
There is intense debate in the industry about best practices for marking, managing and mitigating counterparty risk charges and funding costs. The inclusion of funding valuation adjustment (FVA) for unsecured derivatives has been heavily debated by practitioners and academics, and the marking methodology for debit valuation adjustment (DVA) still raises many questions. According to the Ernst & Young (2012) CVA/FVA Survey, all banks record credit valuation adjustment (CVA) and own credit adjustment (OCA) on liabilities under fair-value option (FVO) accounting; and most banks report DVA. For collateralised derivatives, most dealers have moved to Credit Support Annex (CSA) discounting. But, for uncollateralised derivatives, some banks record an FVA, while others are planning to do so in the near future. Funding is usually priced in at trade inception, but there is no adjustment made to the FVA during the life of the trade for financial reporting purposes. Unsecured CVA will be less of a problem going forward as we move to mandatory clearing for derivatives.11Although mandatory clearing will simplify the VA landscape by reducing the CVA/FVA components in valuations, it will introduce a
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