Landmarks in XVA
First published:
ISBN: 9781782722939
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Derivatives Funding, Netting and Accounting
Christoph Burgard and Mats Kjaer
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
In this chapter we expand previous replication results for the economic value of derivatives including funding costs and counterparty risk to several counterparties and netting sets. We also identify the specific funding and replication strategy that corresponds to a proposed accounting and pricing methodology. The resulting strategy is asymmetric in that negative net cash of the derivatives portfolio is funded at funding rate, whereas positive net cash is invested at a risk-free rate. This asymmetry makes the funding cost adjustment non-additive across netting sets. In contrast, funding transfer mechanisms that recycle positive cash for other funding purposes enable symmetric funding strategies, resulting in additive adjustments across netting sets. These can generate a higher economic value over the life of the trade than the one accounted for with the proposed methodology.
MODEL SET-UP AND ASSET DYNAMICS
Albanese and Andersen (2014) discuss how to account for over-the-counter (OTC) derivatives with funding costs and counterparty risk in a way that is consistent with general accounting principles. This is an important contribution to the debate around funding value
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