IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

Funding Cost and a New Capital Model

  • Hannah, Lincoln
Registered author(s):

    In asset and derivative pricing, funding costs and capital costs are usually considered separately. A derivative will be funded at a given rate such as OIS, LIBOR or the bank’s cost of borrowing, and a cost of capital will be added separately. This paper presents a model that combines the two, using funding attributions from a capital model based on the bank’s Expected Loss (EL) rather than the market standard Probability of Default (PD). The basic idea is: A bank could fund a new asset with the combination of debt and equity that leaves its EL constant. The debt-equity mix gives a funding cost that reflects the risk of the asset rather than the bank, so is a more appropriate rate for assessing the asset than the bank’s Weighted Average Cost of Capital (WACC). In this way, the model facilitates decisions consistent with the Modigliani and Miller theorem (i.e. decisions based on the risk of the asset rather than the bank’s cost of funding). A result of the model is that, in accordance with the view of Hull and White (2012), the cost of funding a derivative is given by its CVA-DVA adjusted price and does not require an additional Funding Value Adjustment (FVA). Some of the funding ideas produced by the model have already been suggested by others, such as Piterbarg (2010) and Burgard and Kjaer (2011).

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

    File URL: http://mpra.ub.uni-muenchen.de/47111/1/MPRA_paper_47111.pdf
    File Function: original version
    Download Restriction: no

    Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 47111.

    as
    in new window

    Length:
    Date of creation: 21 May 2013
    Date of revision:
    Handle: RePEc:pra:mprapa:47111
    Contact details of provider: Postal: Schackstr. 4, D-80539 Munich, Germany
    Phone: +49-(0)89-2180-2219
    Fax: +49-(0)89-2180-3900
    Web page: http://mpra.ub.uni-muenchen.de

    More information through EDIRC

    No references listed on IDEAS
    You can help add them by filling out this form.

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    When requesting a correction, please mention this item's handle: RePEc:pra:mprapa:47111. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Ekkehart Schlicht)

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.