KVA: banks wrestle with the cost of capital
If the price of a derivative should reflect hedging and funding costs, it should also – probably – reflect capital consumption. The resulting adjustment, known as KVA, is gaining tentative acceptance, but the correct methodology is the subject of disputes
In principle, derivatives pricing adjustments are simple, sensible things, and capital valuation adjustment (KVA) is no different. The newest addition to the family – known collectively as XVAs – reflects the capital a trade consumes over its lifetime, which is an obvious source of cost or benefit, and large dealers are increasingly incorporating it in their prices.
"You can't really fly blind in
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