XVA : credit, funding and capital valuation adjustments - Green, Andrew, 1971- (John Wiley & Sons, 2015)
Machine generated contents note: 1 Introduction: The Valuation of Derivative Portfolios 1 1.1 What this book is about 1 1.2 Prices and Values 5 1.3 Trade Economics in Derivative Pricing 7 1.4 Post Crisis Derivative Valuation or How I Learned to Stop Worrying and Love FVA 18 1.5 Reading this Book 24 I CVA and DVA: Counterparty Credit Risk and Credit Valuation Adjustment 25 2 Introducing Counterparty Risk 27 2.1 Defining Counterparty Risk 27 2.2 CVA and DVA: Credit Valuation Adjustment and Debit Valuation Adjustment Defined 29 2.3 The Default Process 30 2.4 Credit Risk Mitigants 32 3 CVA & DVA: Credit and Debit Valuation Adjustment Models 41 3.1 Introduction 41 3.2 Unilateral CVA Model 44 3.3 Bilateral CVA model: CVA & DVA 50 3.4 Modelling dependence between counterparties 56 3.5 Components of a CVA calculation engine 58 3.6 Counterparty level CVA vs. Trade level CVA 60 3.7 Recovery rate / Loss-Given-Default assumptions 63 4 CDS and Default Probabilities 67 4.1 Survival Probabilities and CVA 67 4.2 Historical versus Implied Survival Probabilities 68 4.3 Credit Default Swap Valuation 69 4.4 Bootstrapping the Survival Probability Function 74 4.5 CDS and Capital Relief 79 4.6 Liquid and Illiquid Counterparties 80 5 Analytic Models for CVA and DVA 87 5.1 Analytic CVA Formulae 87 5.2 Interest Rate Swaps 88 5.3 Options: Interest Rate Caplets and Floorlets 90 5.4 FX Forwards 92 6 Modelling Credit Mitigants 95 6.1 Credit Mitigants 95 6.2 Close-out Netting 95 6.3 Break Clauses 97 6.4 Variation Margin and CSA Agreements 100 6.5 Non-financial Security and the Default Waterfall 110 7 Wrong-way and Right-way Risk for CVA 113 7.1 Introduction: Wrong-way and Right-way Risks 113 7.2 Distributional Models of Wrong-way / Right-way Risk 115 7.3 A Generalised Discrete Approach to Wrong-Way Risk 120 7.4 Stochastic Credit Models of Wrong-way / Right-way Risk 121 7.5 Wrong-way / Right-way Risk and DVA 123 II FVA: Funding Valuation Adjustment 125 8 The Discount Curve 127 8.1 Introduction 127 8.2 A Single Curve World 127 8.3 Curve Interpolation and Smooth Curves 130 8.4 Cross-currency Basis 131 8.5 Multi-curve and Tenor Basis 132 8.6 OIS and CSA Discounting 133 8.7 Conclusions: Discounting 141 9 Funding Costs: Funding Valuation Adjustment (FVA) 143 9.1 Explaining Funding Costs 143 9.2 First Generation FVA: Discount Models 151 9.3 Double Counting and DVA 151 9.4 Second Generation FVA: Exposure Models 153 9.5 Residual FVA and CSAs 165 9.6 Asymmetry 166 9.7 Risk Neutrality, Capital and the Modigliani-Miller Theorem 168 9.8 Wrong-way /Right-way Risk and FVA 172 10 Other Sources of Funding Costs: CCPs and MVA 173 10.1 Other Source of Funding Costs 173 10.2 MVA: Margin Valuation Adjustment by Replication 178 10.3 Calculating MVA Efficiently 182 10.4 Conclusions on MVA 191 11 The Funding Curve 193 11.1 Sources for the Funding Curve 193 11.2 Internal Funding Curves 194 11.3 External Funding Curves and Accounting 197 11.4 Multi-currency / Multi-asset Funding 198 III KVA: Capital Valuation Adjustment and Regulation 199 12 Regulation: the Basel II and Basel III Frameworks 201 12.1 Introducing the Regulatory Capital Framework 201 12.2 Market Risk 207 12.3 Counterparty Credit Risk 212 12.4 CVA Capital 215 12.5 Other sources of Regulatory Capital 220 12.6 Forthcoming Regulation with Pricing Impact 222 13 KVA: Capital Valuation Adjustment 235 13.1 Introduction: Capital Costs in Pricing 235 13.2 Extending Semi-replication to Include Capital 236 13.3 The Cost of Capital 239 13.4 KVA for Market Risk, Counterparty Credit Risk and CVA Regulatory Capital 240 13.5 The Size of KVA 241 13.6 Conclusion: KVA 244 14 CVA Risk Warehousing and Tax Valuation Adjustment (TVA) 247 14.1 Risk Warehousing XVA 247 14.2 Taxation 247 14.3 CVA Hedging and Regulatory Capital 248 14.4 Warehousing CVA Risk and Double Semi-Replication 248 15 Portfolio KVA and the Leverage Ratio 255 15.1 The Need for a Portfolio Level Model 255 15.2 Portfolio Level Semi-Replication 256 15.3 Capital Allocation 262 15.4 Cost of Capital to the Business 265 15.5 Portfolio KVA 266 15.6 Calculating Portfolio KVA by Regression 266 IV XVA Implementation 269 16 Hybrid Monte Carlo Models for XVA: Building a model for the Expected-Exposure Engine 271 16.1 Introduction 272 16.2 Choosing the Calibration: Historical versus Implied 277 16.3 The Choice of Interest Rate Modelling Framework 294 16.4 FX and Cross-currency Models 328 16.5 Inflation 336 16.6 Equities 345 16.7 Commodities 350 16.8 Credit 356 17 Monte Carlo Implementation 361 17.1 Introduction 361 17.2 Errors in Monte Carlo 361 17.3 Random Numbers 367 17.4 Correlation 379 17.5 Path Generation 381 18 Monte Carlo Variance Reduction and Performance Enhancements 385 18.1 Introduction 385 18.2 Classic Methods 385 18.3 Orthogonalisation 387 18.4 Portfolio Compression 388 18.5 Conclusion: Making it Go Faster! 390 19 Valuation Models for use with Monte Carlo Exposure Engines 391 19.1 Valuation Models 391 19.2 Implied Volatility Modelling 396 20 Building the Technological Infrastructure 403 20.1 Introduction 403 20.2 System Components 403 20.3 Hardware 417 20.4 Software 420 20.5 Conclusion 434 V Managing XVA 435 21 Calculating XVA Sensitivities 437 21.1 XVA Sensitivities 437 21.2 Finite Difference Approximation 446 21.3 Pathwise Derivatives and Algorithmic Differentiation 450 21.4 Scenarios and Stress Tests 457 22 Managing XVA 459 22.1 Introduction 459 22.2 Organisational Design 459 22.3 XVA, Treasury and Portfolio Management 464 22.4 Active XVA Management 467 22.5 Passive XVA Management 473 22.6 Internal Charging for XVA 473 22.7 Managing Default and Distress 475 VI The Future 477 23 The Future of Derivatives? 479 23.1 Reflecting on the Years of Change 479 23.2 The Market in the Future 479 .