Landmarks in XVA
First published:
ISBN: 9781782722939
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KVA: Capital Valuation Adjustment by Replication
Andrew Green, Chris Kenyon and Chris Dennis
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
Capital is a legal requirement for financial institutions holding derivatives, and the requirements have increased since 2010 (Dodd and Frank 2010; Basel Committee on Banking Supervision 2011), so it is surprising that few papers include it in derivatives pricing (Kenyon and Green 2013, 2014a; Hull and White 2014; Kenyon and Green 2014b). Here, we extend the hedging framework of Burgard and Kjaer (2011b, 2013a) and Kenyon and Kenyon (2013) to price the capital requirements of derivatives trades by replicating their cost, together with the costs of credit and funding. Thus, we present a capital valuation adjustment (KVA) alongside the existing adjustments for credit and funding.
Capital pricing appears challenging because there are hundreds of pages of regulations, lifetime (not just spot) costs are required and calculations at different levels of granularity must be combined. For example, for counterparty credit risk and credit valuation adjustment (CVA), capital netting sets are important, while the whole portfolio is needed to determinate the stressed period for market risk for stressed value-at-risk (SVaR) calculation. Table 21.1 gives a brief list of capital regulations in
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