Advanced Search
MyIDEAS: Login

Discounting Revisited. Valuations under Funding Costs, Counterparty Risk and Collateralization

Contents:

Author Info

  • Fries, Christian P.

Abstract

Looking at the valuation of a swap when funding costs and counterparty risk are neglected (i.e., when there is a unique risk free discounting curve), it is natural to ask "What is the discounting curve of a swap in the presence of funding costs, counterparty risk and/or collateralization". In this note we try to give an answer to this question. The answer depends on who you are and in general it is "There is no such thing as a unique discounting curve (for swaps)." Our approach is somewhat "axiomatic", i.e., we try to make only very few basic assumptions. We shed some light on use of own credit risk in mark-to-market valuations, giving that the mark-to-market value of a portfolio increases when the owner's credibility decreases. We present two different valuations. The first is a mark-to-market valuation which determines the liquidation value of a product. It does, buy construction, exclude any funding cost. The second is a portfolio valuation which determines the replication value of a product including funding costs. We will also consider counterparty risk. If funding costs are presents, i.e., if we value a portfolio by a replication strategy then counterparty risk and funding are tied together: - In addition to the default risk with respect to our exposure we have to consider the loss of a potential funding benefit, i.e., the impact of default on funding. - Buying protection against default has to be funded itself and we account for that. The valuation naturally attributes for wrong-way-risk (i.e., the correlation between counterparty default and counterparty exposure).

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://mpra.ub.uni-muenchen.de/23082/
File Function: original version
Download Restriction: no

File URL: http://mpra.ub.uni-muenchen.de/23227/
File Function: revised version
Download Restriction: no

Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 23082.

as in new window
Length:
Date of creation: 15 May 2010
Date of revision: 30 May 2010
Handle: RePEc:pra:mprapa:23082

Contact details of provider:
Postal: Schackstr. 4, D-80539 Munich, Germany
Phone: +49-(0)89-2180-2219
Fax: +49-(0)89-2180-3900
Web page: http://mpra.ub.uni-muenchen.de
More information through EDIRC

Related research

Keywords: Discounting; Valuation; Counterparty Risk; Collateral; Netting; CVA; DVA; Bond; Swap; Credit Risk; Own Credit Risk; Wrong Way Risk; Liquidity Risk;

Find related papers by JEL classification:

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Damiano Brigo & Andrea Pallavicini & Vasileios Papatheodorou, 2009. "Bilateral counterparty risk valuation for interest-rate products: impact of volatilities and correlations," Papers 0911.3331, arXiv.org, revised Feb 2010.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Lixin Wu, 2013. "CVA and FVA to Derivatives Trades Collateralized by Cash," Papers 1302.0465, arXiv.org.
  2. Andrea Pallavicini & Daniele Perini & Damiano Brigo, 2011. "Funding Valuation Adjustment: a consistent framework including CVA, DVA, collateral,netting rules and re-hypothecation," Papers 1112.1521, arXiv.org, revised Dec 2011.
  3. Marco Bianchetti, 2012. "The Zeeman Effect in Finance: Libor Spectroscopy and Basis Risk Management," Papers 1210.7329, arXiv.org.
  4. Nicola Moreni & Andrea Pallavicini, 2010. "Parsimonious HJM Modelling for Multiple Yield-Curve Dynamics," Papers 1011.0828, arXiv.org.
  5. Tomasz R. Bielecki & Marek Rutkowski, 2013. "Valuation and hedging of OTC contracts with funding costs, collateralization and counterparty credit risk: Part 1," Papers 1306.4733, arXiv.org, revised Jun 2013.
  6. Damiano Brigo, 2011. "Counterparty Risk FAQ: Credit VaR, PFE, CVA, DVA, Closeout, Netting, Collateral, Re-hypothecation, WWR, Basel, Funding, CCDS and Margin Lending," Papers 1111.1331, arXiv.org, revised Jun 2012.
  7. Damiano Brigo & Andrea Pallavicini, 2013. "CCPs, Central Clearing, CSA, Credit Collateral and Funding Costs Valuation FAQ: Re-hypothecation, CVA, Closeout, Netting, WWR, Gap-Risk, Initial and Variation Margins, Multiple Discount Curves, FVA?," Papers 1312.0128, arXiv.org, revised Dec 2013.
  8. Andrea Pallavicini & Daniele Perini & Damiano Brigo, 2012. "Funding, Collateral and Hedging: uncovering the mechanics and the subtleties of funding valuation adjustments," Papers 1210.3811, arXiv.org, revised Dec 2012.
  9. Marco, Bianchetti & Mattia, Carlicchi, 2012. "Interest Rates After The Credit Crunch: Multiple-Curve Vanilla Derivatives and SABR," MPRA Paper 42248, University Library of Munich, Germany.
  10. Alessandro Gnoatto & Martino Grasselli, 2013. "An analytic multi-currency model with stochastic volatility and stochastic interest rates," Papers 1302.7246, arXiv.org, revised Mar 2013.
  11. Marco, Bianchetti, 2011. "The Zeeman Effect in Finance: Libor Spectroscopy and Basis Risk Management," MPRA Paper 42247, University Library of Munich, Germany, revised 27 Oct 2012.
  12. Bianchetti, Marco & Carlicchi, Mattia, 2012. "Markets Evolution After the Credit Crunch," MPRA Paper 44023, University Library of Munich, Germany.
  13. Marco Bianchetti & Mattia Carlicchi, 2013. "Markets Evolution After the Credit Crunch," Papers 1301.7078, arXiv.org.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:pra:mprapa:23082. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Ekkehart Schlicht).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.