KVA: capital valuation adjustment by replication
Credit (CVA), debit (DVA) and funding (FVA) valuation adjustments are now familiar concepts, but banks also pay for capital. Here, Andrew Green, Chris Kenyon and Chris Dennis introduce a capital valuation adjustment (KVA) to pricing by extending the Burgard-Kjaer semi-replication method, considering that capital may reduce funding needs and hedging transactions themselves generate capital requirements
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Capital is a legal requirement for financial institutions holding derivatives, and the requirements have increased over the past few years (Basel Committee on Banking Supervision 2011; Dodd and Frank 2010), so it is surprising few papers include it in derivatives pricing (Hull and White 2014; Kenyon and Green 2013, 2014a,b). Here, we extend the hedging framework of Burgard and Kjaer (2011b, 2013a) and Kenyon and Kenyon (2013) to price the capital requirements of
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