Handling model risk with XVAs

Cyril Bénézet () and Stéphane Crépey ()
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Cyril Bénézet: LaMME - Laboratoire de Mathématiques et Modélisation d'Evry - ENSIIE - Ecole Nationale Supérieure d'Informatique pour l'Industrie et l'Entreprise - UEVE - Université d'Évry-Val-d'Essonne - Université Paris-Saclay - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement, ENSIIE - Ecole Nationale Supérieure d'Informatique pour l'Industrie et l'Entreprise
Stéphane Crépey: LPSM (UMR_8001) - Laboratoire de Probabilités, Statistique et Modélisation - SU - Sorbonne Université - CNRS - Centre National de la Recherche Scientifique - UPCité - Université Paris Cité, UPCité - Université Paris Cité
Authors registered in the RePEc Author Service: Claudio Albanese

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Abstract: In this paper we revisit Burnett (2021) & Burnett and Williams (2021)'s notion of hedging valuation adjustment (HVA), originally intended to deal with dynamic hedging frictions such as transaction costs, in the direction of model risk. The corresponding HVA reconciles a global fair valuation model with the local models used by the different desks of the bank. Model risk and dynamic hedging frictions indeed deserve a reserve, but a risk-adjusted one, so not only an HVA, but also a contribution to the KVA of the bank. The orders of magnitude of the effects involved suggest that local models should not so much be managed via reserves, as excluded altogether.

Keywords: Pricing models; Model risk; Calibration; Market risk; Counterparty credit risk; Transaction Costs; Cross Valuation Adjustments (XVAs) (search for similar items in EconPapers)
Date: 2024-08-26
New Economics Papers: this item is included in nep-rmg
Note: View the original document on HAL open archive server: https://hal.science/hal-03675291v3
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Citations: View citations in EconPapers (2)

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Working Paper: Handling model risk with XVAs (2024)
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