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Funding Value Adjustments

Listed author(s):
  • Leif Andersen
  • Darrell Duffie
  • Yang Song

We demonstrate that the funding value adjustments (FVAs) of major dealers are debt-overhang costs to their shareholders. In order to maximize shareholder value, dealer quotations therefore adjust for FVAs. Contrary to current valuation practice, FVAs are not themselves components of the market values of the positions being financed. The current dealer practice of reducing the computed market values of their positions by FVAs does, however, align incentives between trading desks and shareholders. While others have already suggested that the market values of swaps do not actually include an FVA component, this is the first paper to identify and characterize the true nature of FVA with a structural model of a dealer's balance sheet. We also establish a pecking order for preferred asset financing strategies and provide a new interpretation of the standard debit value adjustment (DVA).

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 23680.

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Date of creation: Aug 2017
Handle: RePEc:nbr:nberwo:23680
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  1. Michael Johannes & Suresh Sundaresan, 2007. "The Impact of Collateralization on Swap Rates," Journal of Finance, American Finance Association, vol. 62(1), pages 383-410, 02.
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  9. Schachermayer, W., 1992. "A Hilbert space proof of the fundamental theorem of asset pricing in finite discrete time," Insurance: Mathematics and Economics, Elsevier, vol. 11(4), pages 249-257, December.
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  12. Duffie, Darrell & Huang, Ming, 1996. " Swap Rates and Credit Quality," Journal of Finance, American Finance Association, vol. 51(3), pages 921-949, July.
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