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Handling model risk with XVAs

Author

Listed:
  • Cyril Bénézet

    (LaMME - Laboratoire de Mathématiques et Modélisation d'Evry - ENSIIE - Ecole Nationale Supérieure d'Informatique pour l'Industrie et l'Entreprise - UEVE - Université d'Évry-Val-d'Essonne - Université Paris-Saclay - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement, ENSIIE - Ecole Nationale Supérieure d'Informatique pour l'Industrie et l'Entreprise)

  • Stéphane Crépey

    (LPSM (UMR_8001) - Laboratoire de Probabilités, Statistique et Modélisation - SU - Sorbonne Université - CNRS - Centre National de la Recherche Scientifique - UPCité - Université Paris Cité, UPCité - Université Paris Cité)

Abstract

In this paper we revisit Burnett (2021) & Burnett and Williams (2021)'s notion of hedging valuation adjustment (HVA), originally intended to deal with dynamic hedging frictions such as transaction costs, in the direction of model risk. The corresponding HVA reconciles a global fair valuation model with the local models used by the different desks of the bank. Model risk and dynamic hedging frictions indeed deserve a reserve, but a risk-adjusted one, so not only an HVA, but also a contribution to the KVA of the bank. The orders of magnitude of the effects involved suggest that local models should not so much be managed via reserves, as excluded altogether.

Suggested Citation

  • Cyril Bénézet & Stéphane Crépey, 2024. "Handling model risk with XVAs," Post-Print hal-03675291, HAL.
    • Handle: RePEc:hal:journl:hal-03675291
    DOI: 10.3934/fmf.2024016
    Note: View the original document on HAL open archive server: https://hal.science/hal-03675291v3
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    References listed on IDEAS

    as
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