In the balance

Funding costs and counterparty credit risk adjustments have become increasingly important contributions to the total value of derivatives positions. Based on a recently developed derivatives valuation framework that incorporates these two effects in a unified way, Christoph Burgard and Mats Kjaer discuss the relationship of the funding cost adjustment to the balance sheet. They also demonstrate two ways in which the funding cost adjustment can be eliminated, resulting in symmetric derivatives values

Funding costs and the bilateral counterparty credit risk of derivatives positions have become increasingly hot topics since the beginning of the credit crisis in 2008. It has become standard practice to adjust derivatives prices for the counterparty risk. Similarly, funding costs are increasingly incorporated into derivatives prices one way or another, but the conceptual foundations for such funding adjustments are much less well understood.

In the balance