Details

The xVA Challenge


The xVA Challenge

Counterparty Risk, Funding, Collateral, Capital and Initial Margin
Wiley Finance 4. Aufl.

von: Jon Gregory

73,99 €

Verlag: Wiley
Format: EPUB
Veröffentl.: 09.04.2020
ISBN/EAN: 9781119509004
Sprache: englisch
Anzahl Seiten: 704

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Beschreibungen

<p><b>A thoroughly updated and expanded edition of the xVA challenge</b></p> <p>The period since the global financial crisis has seen a major re-appraisal of derivatives valuation, generally expressed in the form of valuation adjustments (‘xVAs’). The quantification of xVA is now seen as fundamental to derivatives pricing and valuation. The xVA topic has been complicated and further broadened by accounting standards and regulation. All users of derivatives need to have a good understanding of the implications of xVA. The pricing and valuation of the different xVA terms has become a much studied topic and many aspects are in constant debate both in industry and academia.</p> <ul> <li>Discussing counterparty credit risk in detail, including the many risk mitigants, and how this leads to the different xVA terms</li> <li>Explains why banks have undertaken a dramatic reappraisal of the assumptions they make when pricing, valuing and managing derivatives</li> <li>Covers what the industry generally means by xVA and how it is used by banks, financial institutions and end-users of derivatives</li> <li>Explains all of the underlying regulatory capital (e.g. SA-CCR, SA-CVA) and liquidity requirements (NSFR and LCR) and their impact on xVA</li> <li>Underscores why banks have realised the significant impact that funding costs, collateral effects and capital charges have on valuation</li> <li>Explains how the evolution of accounting standards to cover CVA, DVA, FVA and potentially other valuation adjustments</li> <li>Explains all of the valuation adjustments – CVA, DVA, FVA, ColVA, MVA and KVA – in detail and how they fit together</li> <li>Covers quantification of xVA terms by discussing modelling and implementation aspects.</li> </ul> <p>Taking into account the nature of the underlying market dynamics and new regulatory environment, this book brings readers up to speed on the latest developments on the topic.</p>
<p>List of Spreadsheets xix</p> <p>List of Appendices xxi</p> <p>Acknowledgements xxiii</p> <p>About the Author xxv</p> <p><b>Section 1 Basics</b></p> <p><b>1 Introduction 3</b></p> <p><b>2 Derivatives 5</b></p> <p>2.1 Introduction 5</p> <p>2.2 The Derivatives Market 6</p> <p>2.2.1 Exchange-traded and OTC Derivatives 6</p> <p>2.2.2 Clearing 8</p> <p>2.2.3 Market Overview 9</p> <p>2.2.4 Market Participants and Collateralisation 11</p> <p>2.2.5 Banks and End Users 14</p> <p>2.2.6 ISDA Documentation 16</p> <p>2.2.7 Credit Derivatives 17</p> <p>2.2.8 Financial Weapons of Mass Destruction 18</p> <p>2.2.9 The Lehman Brothers Bankruptcy 19</p> <p>2.3 Derivative Risks 20</p> <p>2.3.1 Market Risk 21</p> <p>2.3.2 Credit Risk 21</p> <p>2.3.3 Operational and Legal Risk 22</p> <p>2.3.4 Liquidity Risk 22</p> <p>2.3.5 Integration of Risk Types 23</p> <p>2.3.6 Counterparty Risk 23</p> <p>2.4 Systemic Risk of Derivatives 24</p> <p>2.4.1 Overview 24</p> <p>2.4.2 Special Purpose Vehicles 24</p> <p>2.4.3 Derivatives Product Companies 25</p> <p>2.4.4 Monolines and CDPCs 26</p> <p>2.5 The Global Financial Crisis and Central Clearing of OTC Derivatives 28</p> <p>2.5.1 OTC Derivatives and the Crisis 28</p> <p>2.5.2 OTC Derivatives Clearing 29</p> <p>2.5.3 CCPs in the Global Financial Crisis 31</p> <p>2.5.4 The Clearing Mandate 32</p> <p>2.5.5 Bilateral Margin Requirements 33</p> <p>2.5.6 CCPs in Context 34</p> <p>2.6 Derivatives Risk Modelling 36</p> <p>2.6.1 Value-at-risk 36</p> <p>2.6.2 Models 38</p> <p>2.6.3 Correlation and Dependency 39</p> <p><b>3 Counterparty Risk and Beyond 41</b></p> <p>3.1 Counterparty Risk 41</p> <p>3.1.1 Counterparty Risk Versus Lending Risk 41</p> <p>3.1.2 Settlement, Pre-settlement, and Margin Period of Risk 42</p> <p>3.1.3 Mitigating Counterparty Risk 45</p> <p>3.1.4 Product Type 46</p> <p>3.1.5 Credit Limits 48</p> <p>3.1.6 Credit Value Adjustment 50</p> <p>3.1.7 What Does CVA Represent? 51</p> <p>3.1.8 Hedging Counterparty Risk and the CVA Desk 52</p> <p>3.2 Beyond Counterparty Risk 54</p> <p>3.2.1 Overview 54</p> <p>3.2.2 Economic Costs of a Derivative 54</p> <p>3.2.3 xVA Terms 55</p> <p>3.3 Components of xVA 57</p> <p>3.3.1 Overview 57</p> <p>3.3.2 Valuation and Mark-to-market 57</p> <p>3.3.3 Replacement Cost and Credit Exposure 58</p> <p>3.3.4 Default Probability, Credit Migration, and Credit Spreads 59</p> <p>3.3.5 Recovery and Loss Given Default 60</p> <p>3.3.6 Funding, Collateral, and Capital Costs 61</p> <p><b>4 Regulation 63</b></p> <p>4.1 Regulation and the Global Financial Crisis 63</p> <p>4.2 Capital Requirements 64</p> <p>4.2.1 Overview 64</p> <p>4.2.2 Capital Ratios 65</p> <p>4.2.3 Risk Type 67</p> <p>4.2.4 Market Risk Capital 68</p> <p>4.2.5 CVA Capital 69</p> <p>4.2.6 CCR Capital 70</p> <p>4.2.7 Leverage Ratio 70</p> <p>4.2.8 Capital Floors 71</p> <p>4.2.9 Large Exposure Framework 72</p> <p>4.2.10 Bank Stress Tests 73</p> <p>4.2.11 Prudent Valuation 73</p> <p>4.3 Liquidity 73</p> <p>4.3.1 Overview 73</p> <p>4.3.2 High-quality Liquid Assets 74</p> <p>4.3.3 Liquidity Coverage Ratio 75</p> <p>4.3.4 Net Stable Funding Ratio 76</p> <p>4.4 Clearing and Margining 77</p> <p>4.4.1 Central Clearing 77</p> <p>4.4.2 Bilateral Margin Requirements 81</p> <p>4.4.3 Exemptions 82</p> <p>4.4.4 CCP Capital Requirements 84</p> <p><b>5 What is xVA? 85</b></p> <p>5.1 Overview 85</p> <p>5.2 Analysis of xVA 86</p> <p>5.2.1 Definition 86</p> <p>5.2.2 Components 86</p> <p>5.2.3 Why Valuation Adjustments? 87</p> <p>5.2.4 Mark-to-market and xVA as a Cost (and Benefit) 88</p> <p>5.2.5 xVAs by Transaction Type 90</p> <p>5.2.6 Overlaps and Portfolio Effects 91</p> <p>5.2.7 CVA is the Least Real Valuation Adjustment 92</p> <p>5.3 Valuation 93</p> <p>5.3.1 Price and Value 93</p> <p>5.3.2 xVA Markets 94</p> <p>5.3.3 Accounting Standards 95</p> <p>5.3.4 Accounting Trends 98</p> <p>5.3.5 Totem 99</p> <p>5.3.6 Contractual Terms and Value 100</p> <p>5.4 Pricing 100</p> <p>5.4.1 Reality or Creating the Right Incentive? 100</p> <p>5.4.2 Approach for Capital 101</p> <p>5.4.3 Approach to Regulatory Ratios 102</p> <p>5.4.4 Lack of Arbitrage 104</p> <p>5.4.5 Entry and Exit Pricing 105</p> <p>5.4.6 xVA Quantification 106</p> <p>5.4.7 Special Cases 106</p> <p><b>Section 2 Risk Mitigation</b></p> <p><b>6 Netting, Close-Out, and Related Aspects 111</b></p> <p>6.1 Overview 111</p> <p>6.2 Cash Flow Netting 112</p> <p>6.2.1 Payment Netting 112</p> <p>6.2.2 Currency Netting and CLS 113</p> <p>6.2.3 Clearing Rings 114</p> <p>6.2.4 Portfolio Compression 115</p> <p>6.2.5 Compression Algorithm 118</p> <p>6.2.6 Benefits of Cashflow Netting 120</p> <p>6.3 Value Netting 121</p> <p>6.3.1 Overview 121</p> <p>6.3.2 Close-out Netting 121</p> <p>6.3.3 Payment Under Close-out 122</p> <p>6.3.4 Close-out and xVA 124</p> <p>6.3.5 ISDA Definitions 125</p> <p>6.3.6 Set-off 129</p> <p>6.4 The Impact of Netting 130</p> <p>6.4.1 Risk Reduction 130</p> <p>6.4.2 The Impact of Netting 131</p> <p>6.4.3 Multilateral Netting and Bifurcation 132</p> <p>6.4.4 Netting Impact on Other Creditors 135</p> <p><b>7 Margin (Collateral) and Settlement 137</b></p> <p>7.1 Termination and Reset Features 137</p> <p>7.1.1 Break Clauses 137</p> <p>7.1.2 Resettable Transactions 140</p> <p>7.2 Basics of Margin/Collateral 141</p> <p>7.2.1 Terminology 141</p> <p>7.2.2 Rationale 142</p> <p>7.2.3 Variation Margin and Initial Margin 144</p> <p>7.2.4 Method of Transfer and Remuneration 145</p> <p>7.2.5 Rehypothecation and Segregation 147</p> <p>7.2.6 Settle to Market 150</p> <p>7.2.7 Valuation Agent, Disputes, and Reconciliations 151</p> <p>7.3 Margin Terms 152</p> <p>7.3.1 The Credit Support Annex 152</p> <p>7.3.2 Types of CSA 153</p> <p>7.3.3 Margin Call Frequency 154</p> <p>7.3.4 Threshold, Initial Margin, and the Minimum Transfer Amount 155</p> <p>7.3.5 Margin Types and Haircuts 157</p> <p>7.3.6 Credit Support Amount Calculations 161</p> <p>7.3.7 Impact of Margin on Exposure 163</p> <p>7.3.8 Traditional Margin Practices in Bilateral and Centrally-cleared Markets 165</p> <p>7.4 Bilateral Margin Requirements 166</p> <p>7.4.1 General Requirements 166</p> <p>7.4.2 Phase-in and Coverage 168</p> <p>7.4.3 Initial Margin and Haircut Calculations 169</p> <p>7.4.4 Eligible Assets and Haircuts 171</p> <p>7.4.5 Implementation and Impact of the Requirements 172</p> <p>7.5 Impact of Margin 173</p> <p>7.5.1 Impact on Other Creditors 173</p> <p>7.5.2 Market Risk and Margin Period of Risk 174</p> <p>7.5.3 Liquidity, FX, and Wrong-way Risks 178</p> <p>7.5.4 Legal and Operational Risks 179</p> <p>7.6 Margin and Funding 180</p> <p>7.6.1 Overview 180</p> <p>7.6.2 Margin and Funding Liquidity Risk 181</p> <p><b>8 Central Clearing 185</b></p> <p>8.1 Evolution of Central Clearing 185</p> <p>8.1.1 Exchange Trading 185</p> <p>8.1.2 Evolution of Complete Clearing 186</p> <p>8.1.3 What is a CCP? 187</p> <p>8.2 Mechanics of Central Clearing 189</p> <p>8.2.1 Landscape 189</p> <p>8.2.2 Novation 191</p> <p>8.2.3 Multilateral Offset and Compression 192</p> <p>8.2.4 Margin and Default Funds 194</p> <p>8.2.5 Clearing Relationships 195</p> <p>8.3 CCP Risk Management 197</p> <p>8.3.1 Overview and Membership Requirements 197</p> <p>8.3.2 Margin 198</p> <p>8.3.3 Default Scenarios and Margin Period of Risk 199</p> <p>8.3.4 The Loss Waterfall 202</p> <p>8.3.5 Comparing Bilateral and Central Clearing 204</p> <p>8.4 Initial Margin and Default Funds 205</p> <p>8.4.1 Coverage of Initial Margin and Default Funds 205</p> <p>8.4.2 Default Fund Versus Initial Margin 206</p> <p>8.4.3 Default Fund Coverage 207</p> <p>8.5 Impact of Central Clearing 209</p> <p>8.5.1 Advantages and Disadvantages of Central Clearing 209</p> <p>8.5.2 Will Mandatory Clearing Kill Credit Value Adjustment? 210</p> <p><b>9 Initial Margin Methodologies 213</b></p> <p>9.1 Role of Initial Margin 213</p> <p>9.1.1 Purpose 213</p> <p>9.1.2 Margin Period of Risk 215</p> <p>9.1.3 Coverage: Quantitative and Qualitative 217</p> <p>9.1.4 Haircuts 218</p> <p>9.1.5 Linkage to Credit Quality 218</p> <p>9.1.6 Cross-margining 220</p> <p>9.2 Initial Margin Approaches 222</p> <p>9.2.1 Simple Approaches 222</p> <p>9.2.2 SPAN<sup>®</sup> 223</p> <p>9.2.3 Value-at-risk and Expected Shortfall 227</p> <p>9.3 Historical Simulation 229</p> <p>9.3.1 Overview 229</p> <p>9.3.2 Look-back Period 230</p> <p>9.3.3 Relative and Absolute Returns 231</p> <p>9.3.4 Volatility Scaling 233</p> <p>9.3.5 Procyclicality 234</p> <p>9.3.6 Current CCP Methodologies 239</p> <p>9.3.7 Computational Considerations 241</p> <p>9.4 Bilateral Margin and SIMM 242</p> <p>9.4.1 Overview 242</p> <p>9.4.2 Standard Schedules 244</p> <p>9.4.3 Variance-covariance Approaches 245</p> <p>9.4.4 The ISDA SIMM 249</p> <p>9.4.5 Implementation of Bilateral Margin Requirements 252</p> <p><b>10 The Impact and Risk of Clearing and Margining 255</b></p> <p>10.1 Risks of Central Clearing 256</p> <p>10.1.1 Historical CCP Problems 256</p> <p>10.1.2 The 1987 Stock Market Crash 258</p> <p>10.1.3 The 2018 Nasdaq Case 259</p> <p>10.1.4 Risks Faced by CCPs 260</p> <p>10.1.5 Risks Caused by CCPs 261</p> <p>10.2 Analysis of a CCP Loss Structure 262</p> <p>10.2.1 Review of the Loss Waterfall 262</p> <p>10.2.2 Impact of Default Fund Exposure 264</p> <p>10.2.3 The Prisoner’s Dilemma and AIPs 265</p> <p>10.2.4 Other Loss Allocation Methods 267</p> <p>10.3 Impact of Margin 271</p> <p>10.3.1 Background and Historical Examples 271</p> <p>10.3.2 Variation Margin 273</p> <p>10.3.3 Initial Margin 275</p> <p>10.3.4 Cost and xVA 276</p> <p>10.3.5 Seniority 277</p> <p>10.3.6 Bilateral and Cleared Markets 277</p> <p><b>Section 3 Building Blocks</b></p> <p><b>11 Future Value and Exposure 283</b></p> <p>11.1 Credit Exposure 283</p> <p>11.1.1 Positive and Negative Exposure 283</p> <p>11.1.2 Definition of Value 284</p> <p>11.1.3 Current and Potential Future Exposure 285</p> <p>11.1.4 Nature of Exposure 286</p> <p>11.1.5 Metrics 288</p> <p>11.2 Drivers of Exposure 292</p> <p>11.2.1 Future Uncertainty 292</p> <p>11.2.2 Cash Flow Frequency 293</p> <p>11.2.3 Curve Shape 294</p> <p>11.2.4 Moneyness 297</p> <p>11.2.5 Combination of Profiles 298</p> <p>11.2.6 Optionality 299</p> <p>11.2.7 Credit Derivatives 300</p> <p>11.3 Aggregation, Portfolio Effects, and the Impact of Collateralisation 302</p> <p>11.3.1 The Impact of Aggregation on Exposure 302</p> <p>11.3.2 Off-market Portfolios 304</p> <p>11.3.3 Impact of Margin 305</p> <p>11.4 Funding, Rehypothecation, and Segregation 308</p> <p>11.4.1 Funding Costs and Benefits 308</p> <p>11.4.2 Differences Between Funding and Credit Exposure 309</p> <p>11.4.3 Impact of Segregation and Rehypothecation 310</p> <p>11.4.4 Impact of Margin on Exposure and Funding 312</p> <p><b>12 Credit Spreads, Default Probabilities, and LGDs 315</b></p> <p>12.1 Default Probability 315</p> <p>12.1.1 Real World and Risk Neutral 315</p> <p>12.1.2 CVA and Risk-neutral Default Probabilities 316</p> <p>12.1.3 Defining Risk-neutral Default Probabilities 319</p> <p>12.1.4 Loss Given Default 321</p> <p>12.2 Credit Curve Mapping 323</p> <p>12.2.1 Overview 323</p> <p>12.2.2 The CDS Market 324</p> <p>12.2.3 Loss Given Default 326</p> <p>12.2.4 General Approach 327</p> <p>12.3 Generic Curve Construction 330</p> <p>12.3.1 General Approach 330</p> <p>12.3.2 Intersection (Bucketing) Approach 332</p> <p>12.3.3 Cross-section Methodology 334</p> <p>12.3.4 Curve Shape, Interpolation, and Indices 336</p> <p>12.3.5 Third-party Providers 337</p> <p>12.3.6 Hedging 338</p> <p><b>13 Regulatory Methodologies 339</b></p> <p>13.1 Overview 339</p> <p>13.2 Credit Risk (Default Risk) Capital 341</p> <p>13.2.1 Standardised Approach 341</p> <p>13.2.2 Internal Ratings-based Approach 342</p> <p>13.2.3 Guarantees 343</p> <p>13.3 CVA (Market Risk) Capital 343</p> <p>13.3.1 The CVA Capital Charge 343</p> <p>13.3.2 Standardised CVA Risk Capital Charge 344</p> <p>13.3.3 BA-CVA 345</p> <p>13.3.4 Advanced CVA Capital Risk Charge 348</p> <p>13.3.5 SA-CVA 351</p> <p>13.3.6 Capital Relief and EU Exemptions 355</p> <p>13.4 Exposure Calculation Methodologies 356</p> <p>13.4.1 Exposure at Default 356</p> <p>13.4.2 Current Exposure Method 358</p> <p>13.4.3 Standardised Approach for Counterparty Credit Risk 361</p> <p>13.4.4 Broader Impact of SA-CCR 366</p> <p>13.4.5 The Internal Model Method 367</p> <p>13.4.6 The Leverage Ratio 372</p> <p>13.4.7 Wrong-way Risk 373</p> <p>13.5 Examples 374</p> <p>13.5.1 Comparison of EAD Methods 374</p> <p>13.5.2 Comparison of Capital Charges 377</p> <p>13.5.3 Impact of Hedges 379</p> <p>13.6 Central Counterparty Capital Requirements 384</p> <p>13.6.1 Background 384</p> <p>13.6.2 Trade Exposure 385</p> <p>13.6.3 Default Fund Exposure 385</p> <p>13.6.4 Client Clearing 386</p> <p><b>14 Funding, Margin, and Capital Costs 389</b></p> <p>14.1 Bank Financing 389</p> <p>14.2 Capital 391</p> <p>14.2.1 Minimum Capital Ratios and Capital Costs 391</p> <p>14.2.2 Leverage Ratio 393</p> <p>14.2.3 Cost of Capital 394</p> <p>14.3 Funding 394</p> <p>14.3.1 Overview 394</p> <p>14.3.2 Cost of Funding 398</p> <p>14.3.3 The Risk-free Rate, IBOR, and OIS 400</p> <p>14.3.4 IBOR Transition 402</p> <p>14.3.5 Funding Spreads 403</p> <p>14.3.6 NSFR and LCR 406</p> <p>14.3.7 Accounting 406</p> <p><b>15 Quantifying Exposure 409</b></p> <p>15.1 Methods for Quantifying Exposure 409</p> <p>15.1.1 Overview 409</p> <p>15.1.2 Parametric Approaches 410</p> <p>15.1.3 Semianalytical Methods 411</p> <p>15.1.4 Monte Carlo Simulation 414</p> <p>15.2 Exposure Allocation 414</p> <p>15.2.1 Overview 414</p> <p>15.2.2 Incremental and Marginal Exposure 414</p> <p>15.2.3 Impact of Dependency 417</p> <p>15.3 Monte Carlo Methodology 419</p> <p>15.3.1 Basic Framework 419</p> <p>15.3.2 Revaluation, Cash Flow Bucketing, and Scaling 421</p> <p>15.3.3 Risk-neutral or Physical Measure 423</p> <p>15.3.4 Aggregation Level 429</p> <p>15.4 Choice of Models 430</p> <p>15.4.1 Overview 430</p> <p>15.4.2 Interest Rates 432</p> <p>15.4.3 Foreign Exchange 435</p> <p>15.4.4 Other Asset Classes 437</p> <p>15.4.5 Correlations, Proxies, and Extrapolation 437</p> <p>15.5 Modelling Margin (Collateral) 439</p> <p>15.5.1 Overview 439</p> <p>15.5.2 Margin Period of Risk 441</p> <p>15.5.3 Modelling Approach 442</p> <p>15.5.4 Initial Margin 445</p> <p>15.6 Examples 448</p> <p>15.6.1 Interest Rate Swap Example 448</p> <p>15.6.2 Trade-level Exposures 450</p> <p>15.6.3 Portfolio Exposures 452</p> <p>15.6.4 Notional Resets 456</p> <p>15.6.5 Impact of Variation Margin 457</p> <p>15.6.6 Impact of Initial Margin 460</p> <p><b>Section 4 The xVAs</b></p> <p><b>16 The Starting Point and Discounting 465</b></p> <p>16.1 The Starting Point 465</p> <p>16.1.1 Basic Valuation 465</p> <p>16.1.2 Perfect Collateralisation 466</p> <p>16.1.3 Collateral or OIS Discounting 467</p> <p>16.2 ColVA and Discounting 469</p> <p>16.2.1 Definition of ColVA 469</p> <p>16.2.2 Asymmetry 470</p> <p>16.2.3 Cheapest-to-deliver Optionality 473</p> <p>16.2.4 Non-cash Margin 478</p> <p>16.2.5 The End of ColVA 479</p> <p>16.3 Beyond Perfect Collateralisation – xVA 480</p> <p>16.3.1 Overview 480</p> <p>16.3.2 Definition of xVA Terms 482</p> <p><b>17 CVA 485</b></p> <p>17.1 Overview 485</p> <p>17.2 Credit Value Adjustment 486</p> <p>17.2.1 CVA Compared to Traditional Credit Pricing 486</p> <p>17.2.2 Direct and Path-wise CVA Formulas 487</p> <p>17.2.3 CVA as a Spread 492</p> <p>17.2.4 Special Cases 493</p> <p>17.2.5 Credit Spread Effects 493</p> <p>17.2.6 Loss Given Default 495</p> <p>17.3 Debt Value Adjustment 498</p> <p>17.3.1 Accounting Background 498</p> <p>17.3.2 DVA, Price, and Value 499</p> <p>17.3.3 Bilateral CVA Formula 500</p> <p>17.3.4 Close-out and Default Correlation 502</p> <p>17.3.5 The Use of DVA 503</p> <p>17.4 CVA Allocation 506</p> <p>17.4.1 Incremental CVA 506</p> <p>17.4.2 Marginal CVA 509</p> <p>17.5 Impact of Margin 510</p> <p>17.5.1 Overview 510</p> <p>17.5.2 Example 511</p> <p>17.5.3 Initial Margin 512</p> <p>17.5.4 CVA to CCPs 513</p> <p>17.6 Wrong-way Risk 514</p> <p>17.6.1 Overview 514</p> <p>17.6.2 Quantification of WWR in CVA 516</p> <p>17.6.3 Wrong-way Risk Models 518</p> <p>17.6.4 Jump Approaches 522</p> <p>17.6.5 Credit Derivatives 524</p> <p>17.6.6 Collateralisation and WWR 525</p> <p>17.6.7 Central Clearing and WWR 526</p> <p><b>18 FVA 529</b></p> <p>18.1 Overview 529</p> <p>18.2 FVA and Discounting 530</p> <p>18.2.1 Market Practice 530</p> <p>18.2.2 Source of Funding Costs and Benefits 531</p> <p>18.2.3 Definition of FVA 534</p> <p>18.2.4 Symmetric FVA Formula 535</p> <p>18.2.5 CVA/DVA/FVA Framework 539</p> <p>18.2.6 The FVA Debate 546</p> <p>18.2.7 Funding Costs and FVA Accounting 548</p> <p>18.3 Asymmetric FVA 551</p> <p>18.3.1 Overview 551</p> <p>18.3.2 Asymmetric FVA 552</p> <p>18.3.3 FVA Allocation 555</p> <p>18.3.4 NSFR Invariance 558</p> <p>18.3.5 Funding Strategies 560</p> <p>18.3.6 LCR Costs 561</p> <p>18.3.7 Funding and Wrong-way Risk 563</p> <p><b>19 KVA 565</b></p> <p>19.1 Overview 565</p> <p>19.2 Capital Value Adjustment (KVA) 566</p> <p>19.2.1 Return on Capital 566</p> <p>19.2.2 KVA Formula 567</p> <p>19.2.3 Capital Profiles 568</p> <p>19.2.4 KVA Example 572</p> <p>19.2.5 Implementation of KVA 573</p> <p>19.2.6 The Leverage Ratio 575</p> <p>19.3 Management of KVA 577</p> <p>19.3.1 Current Treatment of KVA by Banks 577</p> <p>19.3.2 Optimal KVA Management 580</p> <p>19.3.3 Discounting 585</p> <p>19.3.4 KVA Accounting 585</p> <p>19.4 KVA Overlaps 587</p> <p>19.4.1 CVA and KVA 587</p> <p>19.4.2 FVA and KVA 589</p> <p><b>20 MVA 591</b></p> <p>20.1 Overview 591</p> <p>20.2 Initial Margin Funding Costs 594</p> <p>20.2.1 Introduction 594</p> <p>20.2.2 MVA Formula 594</p> <p>20.2.3 EIM Term 595</p> <p>20.2.4 Computation Challenges 599</p> <p>20.2.5 Pricing and MVA Example 600</p> <p>20.3 MVA 602</p> <p>20.3.1 A Need to Charge MVA? 602</p> <p>20.3.2 Accounting MVA 603</p> <p>20.3.3 Contingent MVA 603</p> <p>20.3.4 CCP Basis 604</p> <p>20.4 Link to KVA 606</p> <p>20.4.1 Overview 606</p> <p>20.4.2 Example 607</p> <p><b>21 Actively Managing xVA and the Role of an xVA Desk 609</b></p> <p>21.1 The Role of an xVA Desk 609</p> <p>21.1.1 Motivation 609</p> <p>21.1.2 Charging Structure and Coverage 611</p> <p>21.1.3 Time Decay 614</p> <p>21.1.4 Profit Centre or Utility? 615</p> <p>21.1.5 Pricing 617</p> <p>21.2 Hedging 619</p> <p>21.2.1 Overview 619</p> <p>21.2.2 Sensitivities 621</p> <p>21.2.3 Gamma, Cross-gamma, Tail Risk, and Rebalancing 625</p> <p>21.2.4 Market Practice 627</p> <p>21.2.5 Jump to Default Risk 629</p> <p>21.2.6 Beta Hedging 630</p> <p>21.2.7 Risk Limits and P&L Explain 631</p> <p>21.2.8 Examples 633</p> <p>21.2.9 Impact on Capital 634</p> <p>21.2.10 Pushing xVA into Base Value 638</p> <p>21.3 Operation of an xVA Desk 638</p> <p>21.3.1 Interaction with a Treasury 638</p> <p>21.3.2 Capital 640</p> <p>21.3.3 Systems and Quantification 641</p> <p>21.3.4 xVA Optimisation 645</p> <p>Glossary 649</p> <p>References 653</p> <p>Index 667</p>
<p><b>JON GREGORY, P<small>H</small>D,</b> is an independent expert specialising in counterparty risk and related aspects. He has worked on many aspects of credit risk in his career, being previously with Barclays Capital, BNP Paribas and Citigroup. He is a senior advisor for Solum Financial Derivatives Advisory and is a faculty member for the Certificate of Quantitative Finance (CQF). Jon has a PhD from Cambridge University.
<p> Praise for <b>The xVA Challenge</b> <p>"The issue of counterparty risk has undergone rapid change since the credit crisis. All end users of OTC derivatives are affected by these changes. The title 'xVA' reflects the increased complexity generated by these changes. Jon Gregory provides the reader with a comprehensive, yet readable, discourse on the different facets of counterparty risk. This book is an essential reading for regulators and all users of OTC derivatives."<br/> <b>—Stuart M. Turnbull,</b> Bauer Chaired Professor of Finance, Bauer College of Business, University of Houston <p>"Jon Gregory is one of the godfathers of the VA story. He is amongst the few who can demystify the puzzle and this book is a key tool for bringing light into these dark matters."<br/> <b>—Wim Schoutens,</b> Independent consultant; Professor in financial engineering, University of Leuven, Belgium <p>"This is by far the clearest and most comprehensive reference work on counterparty credit risk and related value adjustments. With this new edition, Jon Gregory explains the latest changes in market practice, along with critical expert commentary."<br/> <b>—Darrell Duffie,</b> Dean Witter Distinguished Professor of Finance, Stanford Graduate School of Business <p>"The previous editions of Jon Gregory's books on the post-crisis over-the-counter derivatives markets were classics, packed with a wealth of information. This new edition greatly extends the coverage of the first three editions. Like them, it is a must-buy for anyone involved with derivatives markets. Congratulations Jon on another excellent book."<br/> <b>—John Hull,</b> Maple Financial Group Chair in Derivatives and Risk Management - Rotman School of Management, University of Toronto

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