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FVA and CVA under margining

Author

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  • Lixin Wu
  • Chonhong Li

Abstract

Purpose - – The purpose of this paper is to provide a framework of replication pricing of derivatives and identify funding valuation adjustment (FVA) and credit valuation adjustments (CVA) as price components. Design/methodology/approach - – The authors propose the notion of bilateral replication pricing. In the absence of funding cost, it reduces to unilateral replication pricing. The absence of funding costs, it introduces bid–ask spreads. Findings - – The valuation of CVA can be separated from that of FVA, so-called split up. There may be interdependence between FVA and the derivatives value, which then requires a recursive procedure for their numerical solution. Research limitations/implications - – The authors have assume deterministic interest rates, constant CDS rates and loss rates for the CDS. The authors have also not dealt with re-hypothecation risks. Practical implications - – The results of this paper allow user to identify CVA and FVA, and mark to market their derivatives trades according to the recent market standards. Originality/value - – For the first time, a line between the risk-neutral pricing measure and the funding risk premiums is drawn. Also, the notion of bilateral replication pricing extends the unilateral replication pricing.

Suggested Citation

  • Lixin Wu & Chonhong Li, 2015. "FVA and CVA under margining," Studies in Economics and Finance, Emerald Group Publishing Limited, vol. 32(3), pages 298-321, August.
    • Handle: RePEc:eme:sefpps:v:32:y:2015:i:3:p:298-321
    DOI: 10.1108/SEF-08-2014-0162
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    Cited by:

    1. Lixin Wu & Dawei Zhang, 2020. "xVA: DEFINITION, EVALUATION AND RISK MANAGEMENT," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 23(01), pages 1-24, February.

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