XVA

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Praise for CHANGE WITH CONFIDENCE “Phil Buckley is a world-class change leader and world-champion enthusiast for effective change management. Straightforward and engaging, Phil addresses the 50 questions all change managers need to answer with confidence in order to succeed. Rare too for an author in this field, he shares the ‘how-not-to’ as well as the ‘how-to.’ This is a book any manager wanting to succeed in change should keep close by.” – Professor Chris Bones, Dean Emeritus, Henley Business School; Professor of Leadership, University of Manchester; and award-winning author of The Cult of the Leader “Phil Buckley’s book gives excellent, practical advice on how to implement change in any private or public organization. What makes Change with Confidence so special is that it is organized around questions that anybody who is engaged in or leading change management will find to be key to their success. The real-life examples given for each question make this a very readable book. A must-buy for anybody who wants to avoid the most common mistakes in change management.” – Stefan A. Bomhard, President, Europe, Bacardi Martini Group “Change with Confidence provides leaders and leaders of change with a wealth of knowledge and experience that they can apply to their own change initiatives, and the real-world examples provide additional clarity on how to successfully manage or avoid common pitfalls.” – David Sculthorpe, CEO, Heart and Stroke Foundation of Canada Change Management is about helping people decide to change successfully If you have been charged with leading a change initiative, chances are you were chosen for the job—that is, you didn’t volunteer, but rather were tapped to lead or manage a large change project. You may have been given a short briefing and left to your own devices to succeed or fail in an uncertain, often threatening, environment. You may find yourself struggling to adapt your skill set to unfamiliar and anxiety-inducing conditions, conscious that your performance will affect your future career paths. Change with Confidence addresses the 50 biggest questions that change leaders ask time and again, and provides the context, examples, and advice to answer them well, and to enable successful, sustainable change. Whether you’re trying to figure it out, are in the planning stage, are actively managing or are working to make it stick, you’ll find guidance for a wide range of issues, including: Analyzing previous change initiatives to see what worked, what didn’t, and why Finding out who can influence your success or failure, help you, or trip you up Determining what resources you’ll need and how to get them Overcoming change fatigue and opposition to change. Although every change has its own circumstances, there are proven processes, tactics, and behaviors that lead to lasting success. Change with Confidence offers practical, experience-based advice on a difficult and stressful challenge.

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Green Andrew

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XVA: Credit, Funding and Capital Valuation Adjustments

ANDREW GREEN

This edition first published 2016

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Library of Congress Cataloging-in-Publication Data

Green, Andrew,

XVA: credit, funding and capital valuation adjustments / Andrew Green.

pages cm. – (The wiley finance series)

Includes bibliographical references and index.

ISBN 978-1-118-55678-8 (hardback) – ISBN 978-1-118-55675-7 (ebk) – ISBN 978-1-118-55676-4 (ebk) – ISBN 978-1-119-16123-3 (ebk) 1. Finance. 2. Derivative securities. I. Title.

HG173.G744 2015

332.64′57–dc23

2015019353

A catalogue record for this book is available from the British Library.

ISBN 978-1-118-55678-8 (hardback) ISBN 978-1-118-55675-7 (ebk)

ISBN 978-1-118-55676-4 (ebk) ISBN 978-1-119-16123-3 (obk)

Cover Design: Wiley

Cover Image: ©iStock/Tuomas Kujansuu

For Simone

Acknowledgements

I would like to thank both Dr Chris Dennis and Dr Chris Kenyon for kindly agreeing to review this book prior to publication and for their work on a number of research topics that are contained within this book. Any errors or omissions are my own, however.

I would also like to thank the many colleagues and peers from both market and academia with whom I have had useful discussions on quantitative finance over many years. This includes colleagues from my current and past employers but also includes a great many others.

I owe a debt of gratitude to my many teachers over a number of years, but perhaps most of all to my DPhil supervisor, Professor James Binney, whose own publications inspired me ultimately to write my own book.

Finally I would like to thank friends and family for putting up with my absence during the writing process.

CHAPTER 1

Introduction: The Valuation of Derivative Portfolios

Price is what you pay. Value is what you get.

– Warren Buffett

American business magnate, investor and philanthropist (1930–)

1.1 What this book is about

This book is about XVA or Valuation Adjustments, the valuation of the credit, funding and regulatory capital requirements embedded in derivative contracts. It introduces Credit Valuation Adjustment (CVA) and Debit Valuation Adjustment (DVA) to account for credit risk, Funding Valuation Adjustment (FVA) for the impact of funding costs including Margin Valuation Adjustment (MVA) for the funding cost associated with initial margin, Capital Valuation Adjustment (KVA) for the impact of Regulatory Capital and Tax Valuation Adjustment (TVA) for the impact of taxation on profits and losses. The book provides detailed descriptions of models to calculate the valuation adjustments and the technical infrastructure required to calculate them efficiently. However, more fundamentally this book is about the valuation and pricing of derivative contracts. The reality is that credit, funding and capital concerns are very far from minor adjustments to the value of a single derivative contract or portfolio of derivatives. The treatment of CVA, DVA, FVA, MVA, KVA and TVA as adjustments reflects the historical development of derivative models and typical bank organisational design rather than the economic reality that places credit, funding and capital costs at the centre of accurate pricing and valuation of derivatives.