Risky funding: a unified framework for counterparty and liquidity risk

Massimo Morini and Andrea Prampolini

MPRA Paper from University Library of Munich, Germany

Abstract: We analyze the liquidity component in a derivative transaction where both counterparties can default, and the effect of a counterparty's default probability on his funding costs and benefits. The analysis shows that the value of a transaction is influenced not by the total cost of funding of a counterparty, but only by that component of the cost of funding corresponding to his bond-CDS basis spread, and this regulates which trades are possible in the market. Moreover, we find that the DVA can be represented as a funding benefit for the borrower, alternatively to the market standard that considers it a benefit coming from the borrower's own default risk.

Keywords: counterparty risk; CVA; DVA; funding; liquidity; bond-CDS basis (search for similar items in EconPapers)
JEL-codes: G13 (search for similar items in EconPapers)
Date: 2010-05-20
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Citations: View citations in EconPapers (2)

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https://mpra.ub.uni-muenchen.de/24720/1/MPRA_paper_24720.pdf revised version (application/pdf)

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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:23555

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