Risky funding: a unified framework for counterparty and liquidity risk
AbstractWe 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.
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Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 23555.
Date of creation: 20 May 2010
Date of revision:
counterparty risk; CVA; DVA; funding; liquidity; bond-CDS basis;
Find related papers by JEL classification:
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-07-10 (All new papers)
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.:
- Jarrow, Robert A & Turnbull, Stuart M, 1995. " Pricing Derivatives on Financial Securities Subject to Credit Risk," Journal of Finance, American Finance Association, vol. 50(1), pages 53-85, March.
- Boukhobza, Ali & Maetz, Jerome, 2012. "CVA, Wrong Way Risk, Hedging and Bermudan Swaption," MPRA Paper 42144, University Library of Munich, Germany.
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