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Credit Valuation Adjustment Compression by Genetic Optimization

Marc Chataigner () and Stéphane Crépey ()
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Marc Chataigner: LaMME, Univ Evry, CNRS, Université Paris-Saclay, CEDEX, 91037 Évry, France
Stéphane Crépey: LaMME, Univ Evry, CNRS, Université Paris-Saclay, CEDEX, 91037 Évry, France

Risks, 2019, vol. 7, issue 4, 1-21

Abstract: Since the 2008–2009 financial crisis, banks have introduced a family of X-valuation adjustments (XVAs) to quantify the cost of counterparty risk and of its capital and funding implications. XVAs represent a switch of paradigm in derivative management, from hedging to balance sheet optimization. They reflect market inefficiencies that should be compressed as much as possible. In this work, we present a genetic algorithm applied to the compression of credit valuation adjustment (CVA), the expected cost of client defaults to a bank. The design of the algorithm is fine-tuned to the hybrid structure, both discrete and continuous parameter, of the corresponding high-dimensional and nonconvex optimization problem. To make intensive trade incremental XVA computations practical in real-time as required for XVA compression purposes, we propose an approach that circumvents portfolio revaluation at the cost of disk memory, storing the portfolio exposure of the night so that the exposure of the portfolio augmented by a new deal can be obtained at the cost of computing the exposure of the new deal only. This is illustrated by a CVA compression case study on real swap portfolios.

Keywords: counterparty risk; credit valuation adjustment (CVA); XVA (X-valuation adjustments) compression; genetic algorithm (search for similar items in EconPapers)
JEL-codes: C G0 G1 G2 G3 M2 M4 K2 (search for similar items in EconPapers)
Date: 2019
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Handle: RePEc:gam:jrisks:v:7:y:2019:i:4:p:100-:d:272095