From FVA to KVA: including cost of capital in derivatives pricing
Youssef Elouerkhaoui addresses the problem of pricing derivatives with credit valuation adjustment, funding, initial margin and capital costs. By extending the fundamental funding invariance principle, he shows how to compute the capital valuation adjustment (KVA) term for an IMM bank and how to tackle the issue with nested P and Q expectations. Finally, he compares the KVA approach with the standard risk-weighted asset hurdle rate analysis
With the increased capital requirements under Basel III, capital has become the main constraint for derivatives businesses; the profitability metric used has shifted from a net revenue or a market share measure to a return on equity (ROE) measure. ROE hurdle rates are now the de facto drivers of valuation (including both Basel III risk-weighted asset (RWAs) and supplementary leverage ratios (SLRs)). This is so critical to business profitability that banks are willing to take a profit and loss (P
Only users who have a paid subscription or are part of a corporate subscription are able to print or copy content.
To access these options, along with all other subscription benefits, please contact info@risk.net or view our subscription options here: http://subscriptions.risk.net/subscribe
You are currently unable to print this content. Please contact info@risk.net to find out more.
You are currently unable to copy this content. Please contact info@risk.net to find out more.
Copyright Infopro Digital Limited. All rights reserved.
You may share this content using our article tools. Printing this content is for the sole use of the Authorised User (named subscriber), as outlined in our terms and conditions - https://www.infopro-insight.com/terms-conditions/insight-subscriptions/
If you would like to purchase additional rights please email info@risk.net
Copyright Infopro Digital Limited. All rights reserved.
You may share this content using our article tools. Copying this content is for the sole use of the Authorised User (named subscriber), as outlined in our terms and conditions - https://www.infopro-insight.com/terms-conditions/insight-subscriptions/
If you would like to purchase additional rights please email info@risk.net
More on Markets
Europe’s FXPBs take advantage of margin rule carve-out
Some big FX options users have switched to dealers capitalising on regulatory mismatch
Breaking out of the cells: banks’ long goodbye to spreadsheets
Dealers are cutting back on Excel amid tighter regulation and risk concerns
FXSpotStream looks to growth products beyond spot
New chief exec Jeff Ward highlights NDFs and FX swaps as next boom area for the venue
BNP Paribas targets hedge funds with equity vol carry options
Bank aims to meet demand for QIS options extending beyond commodities
Canada’s triparty repo launch aims to fill C$60bn void
Test trades on TMX/Clearstream platform represent “quantum leap” for creaking funding markets
SG trader dismissals shine spotlight on intraday limit controls
Risk experts say many banks rely on daily reports and can’t effectively monitor intraday limits in real time
Hedge funds’ pricing often trumps other buy-siders – SNB
Research shows “advantageous” prices result in outperformance of 139bp trading USD/CHF
Softer FX rules for China QFIs set to boost CNY competition
Freedom to circumvent local custodians a plus for pricing and best execution – State Street
Most read
- Basel Committee reviewing design of liquidity ratios
- Breaking out of the cells: banks’ long goodbye to spreadsheets
- Too soon to say good riddance to banks’ public enemy number one