Capital Valuation Adjustment and Funding Valuation Adjustment

Claudio Albanese, Simone Caenazzo () and Stéphane Crépey ()
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Simone Caenazzo: LaMME - Laboratoire de Mathématiques et Modélisation d'Evry - INRA - Institut National de la Recherche Agronomique - UEVE - Université d'Évry-Val-d'Essonne - CNRS - Centre National de la Recherche Scientifique
Stéphane Crépey: LaMME - Laboratoire de Mathématiques et Modélisation d'Evry - INRA - Institut National de la Recherche Agronomique - UEVE - Université d'Évry-Val-d'Essonne - CNRS - Centre National de la Recherche Scientifique

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Abstract: In the aftermath of the 2007 global financial crisis, banks started reflecting into derivative pricing the cost of capital and collateral funding through XVA metrics. Here XVA is a catch-all acronym whereby X is replaced by a letter such as C for credit, D for debt, F for funding, K for capital and so on, and VA stands for valuation adjustment. This behaviour is at odds with economies where markets for contingent claims are complete, whereby trades clear at fair valuations and the costs for capital and collateral are both irrelevant to investment decisions. In this paper, we set forth a mathematical formalism for derivative portfolio management in incomplete markets for banks. A particular emphasis is given to the problem of finding optimal strategies for retained earnings which ensure a sustainable dividend policy.

Keywords: Market incompleteness; counterparty risk; cost of capital; cost of funding; variation margin; initial margin; FVA; MVA; KVA (search for similar items in EconPapers)
Date: 2016-03-09
Note: View the original document on HAL open archive server: https://hal.science/hal-01285363v1
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Citations: View citations in EconPapers (5)

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Working Paper: Capital Valuation Adjustment and Funding Valuation Adjustment (2016)
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