Credit, funding, margin, and capital valuation adjustments for bilateral portfolios

Claudio Albanese; Simone Caenazzo; Stéphane Crépey

doi:10.1186/s41546-017-0019-2

Article Contents

2017, Volume 2: 7. Doi: 10.1186/s41546-017-0019-2

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Credit, funding, margin, and capital valuation adjustments for bilateral portfolios

1 IMEX, London, UK;
2 CASS School of Business, London, UK;
3 LaMME, Univ Evry, CNRS, Université Paris-Saclay, 91037, Evry, France

Received: January 30, 2017

Revised: May 28, 2017

Published: September 2020

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Abstract

We apply to the concrete setup of a bank engaged into bilateral trade portfolios the XVA theoretical framework of Albanese and Crépey (2017), whereby so-called contra-liabilities and cost of capital are charged by the bank to its clients, on top of the fair valuation of counterparty risk, in order to account for the incompleteness of this risk. The transfer of the residual reserve credit capital from shareholders to creditors at bank default results in a unilateral CVA, consistent with the regulatory requirement that capital should not diminish as an effect of the sole deterioration of the bank credit spread. Our funding cost for variation margin (FVA) is defined asymmetrically since there is no benefit in holding excess capital in the future. Capital is fungible as a source of funding for variation margin, causing a material FVA reduction. We introduce a specialist initial margin lending scheme that drastically reduces the funding cost for initial margin (MVA). Our capital valuation adjustment (KVA) is defined as a risk premium, i.e. the cost of remunerating shareholder capital at risk at some hurdle rate.

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Mathematics Subject Classification: 91B25;91B26;91B30;91G20;91G40.

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