A Note on Discounting and Funding Value Adjustments for Derivatives

Meng Han, Yeqi He and Hu Zhang

MPRA Paper from University Library of Munich, Germany

Abstract: In this paper, valuation of a derivative partially collateralized in a specific foreign currency defined in its credit support annex traded between default-free counterparties is studied. Two pricing approaches -- by hedging and by expectation -- are presented to obtain the same valuation formulae. Our findings show that the current marking-to-market value of such a derivative consists of three components: the price of the perfectly collateralized derivative (a.k.a. price by collateral rate discounting), the value adjustment due to different funding spreads between the payoff currency and the collateral currency, and the value adjustment due to funding requirements of the uncollateralized exposure. These results generalize previous works on discounting for fully collateralized derivatives and on funding value adjustment for partially collateralized or uncollateralized derivatives.

Keywords: CSA; collateral; foreign collateral; derivative pricing; hedging; martingale pricing; FVA; funding cost; funding and discounting (search for similar items in EconPapers)
JEL-codes: G12 G13 (search for similar items in EconPapers)
Date: 2013-02-18
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https://mpra.ub.uni-muenchen.de/44495/1/MPRA_paper_44495.pdf original version (application/pdf)
https://mpra.ub.uni-muenchen.de/44526/1/MPRA_paper_44526.pdf revised version (application/pdf)

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