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Warehousing Credit (CVA) Risk, Capital (KVA) and Tax (TVA) Consequences

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  • Chris Kenyon
  • Andrew Green

Abstract

Credit risk may be warehoused by choice, or because of limited hedging possibilities. Credit risk warehousing increases capital requirements and leaves open risk. Open risk must be priced in the physical measure, rather than the risk neutral measure, and implies profits and losses. Furthermore the rate of return on capital that shareholders require must be paid from profits. Profits are taxable and losses provide tax credits. Here we extend the semi-replication approach of Burgard and Kjaer (2013) and the capital formalism (KVA) of Green, Kenyon, and Dennis (2014) to cover credit risk warehousing and tax, formalized as double-semi-replication and TVA (Tax Valuation Adjustment) to enable quantification.

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  • Chris Kenyon & Andrew Green, 2014. "Warehousing Credit (CVA) Risk, Capital (KVA) and Tax (TVA) Consequences," Papers 1407.3201, arXiv.org, revised Jan 2015.
    • Handle: RePEc:arx:papers:1407.3201
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    References listed on IDEAS

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    1. Andrew Green & Chris Kenyon, 2014. "MVA: Initial Margin Valuation Adjustment by Replication and Regression," Papers 1405.0508, arXiv.org, revised Jan 2015.
    2. Antje Berndt & Rohan Douglas & Darrell Duffie & Mark Ferguson, "undated". "Measuring Default Risk Premia from Default Swap Rates and EDFs," GSIA Working Papers 2006-E31, Carnegie Mellon University, Tepper School of Business.
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