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An indifference approach to the cost of capital constraints: KVA and beyond

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  • Damiano Brigo
  • Marco Francischello
  • Andrea Pallavicini

Abstract

The strengthening of capital requirements has induced banks and traders to consider charging a so called capital valuation adjustment (KVA) to the clients in OTC transactions. This roughly corresponds to charge the clients ex-ante the profit requirement that is asked to the trading desk. In the following we try to delineate a possible way to assess the impact of capital constraints in the valuation of a deal. We resort to an optimisation stemming from an indifference pricing approach, and we study both the linear problem from the point of view of the whole bank and the non-linear problem given by the viewpoint of shareholders. We also consider the case where one optimises the median rather than the mean statistics of the profit and loss distribution.

Suggested Citation

  • Damiano Brigo & Marco Francischello & Andrea Pallavicini, 2017. "An indifference approach to the cost of capital constraints: KVA and beyond," Papers 1708.05319, arXiv.org.
    • Handle: RePEc:arx:papers:1708.05319
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    References listed on IDEAS

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    1. Andrew Green & Chris Kenyon, 2014. "KVA: Capital Valuation Adjustment," Papers 1405.0515, arXiv.org, revised Oct 2014.
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    4. Claudio Albanese & Simone Caenazzo & Stéphane Crépey, 2016. "Capital Valuation Adjustment and Funding Valuation Adjustment," Working Papers hal-01285363, HAL.
    5. Foldes, Lucien, 2000. "Valuation and martingale properties of shadow prices: An exposition," Journal of Economic Dynamics and Control, Elsevier, vol. 24(11-12), pages 1641-1701, October.
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    11. Lucien Foldes, 2000. "Valuation and Martingale Properties of Shadow Prices," FMG Discussion Papers dp342, Financial Markets Group.
    12. Damiano Brigo & Andrea Pallavicini, 2014. "Nonlinear consistent valuation of CCP cleared or CSA bilateral trades with initial margins under credit, funding and wrong-way risks," Journal of Financial Engineering (JFE), World Scientific Publishing Co. Pte. Ltd., vol. 1(01), pages 1-60.
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    Cited by:

    1. Damiano Brigo & Cristin Buescu & Marco Francischello & Andrea Pallavicini & Marek Rutkowski, 2018. "Risk-neutral valuation under differential funding costs, defaults and collateralization," Papers 1802.10228, arXiv.org.

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