The xVA Challenge: Counterparty Risk, Funding, Collateral, Capital and Initial Margin (Wiley Finance)

A thoroughly updated and expanded edition of the xVA challenge 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. • Discussing counterparty credit risk in detail, including the many risk mitigants, and how this leads to the different xVA terms • Explains why banks have undertaken a dramatic reappraisal of the assumptions they make when pricing, valuing and managing derivatives • Covers what the industry generally means by xVA and how it is used by banks, financial institutions and end-users of derivatives • Explains all of the underlying regulatory capital (e.g. SA-CCR, SA-CVA) and liquidity requirements (NSFR and LCR) and their impact on xVA • Underscores why banks have realised the significant impact that funding costs, collateral effects and capital charges have on valuation • Explains how the evolution of accounting standards to cover CVA, DVA, FVA and potentially other valuation adjustments • Explains all of the valuation adjustments - CVA, DVA, FVA, ColVA, MVA and KVA - in detail and how they fit together • Covers quantification of xVA terms by discussing modelling and implementation aspects. 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. "In 2007, a so-called credit crisis began. This crisis eventually became more severe and long-lasting than could have ever been anticipated. One result of the "global financial crisis" was a clear realisation that banks needed to be subject to much stricter regulation and conservative requirements over aspects such as capital. It has become all too clear that there has been a significant "too big to fail" problem in that the biggest banks and financial firms could not be allowed to fail and therefore should be subject to even tighter risk controls and oversight. It is not, therefore, surprising that new regulation started to emerge very quickly with the Dodd--Frank Act being signed into law in July 2010 and the development and rapid implementation of Basel III guidelines for regulatory capital. Much of the regulation is aimed squarely at the over-the-counter (OTC) derivatives market where aspects such as counterparty risk and liquidity risk were shown to be so significant in the global financial crisis. This pace and range of new regulation has been quite dramatic. Additional capital charges, a central clearing mandate and bilateral rules for posting of collateral have all been aimed at counterparty risk reduction and control. At the same time as the regulatory change, banks have undertaken a dramatic reappraisal of the assumptions they make when pricing, valuing and managing OTC derivatives. Whilst counterparty risk has always been a consideration, its importance has grown, which is seen via significant credit value adjustment (CVA) values reported in bank's financial statements. Banks have also realised the significant impact that funding costs, collateral effects and capital charges have on valuation. Under accounting rules, CVA was subject to a very strange marriage to DVA (debt value adjustment). Nonetheless, this marriage has produced many offspring such as FVA (funding value adjustment), ColVA (collateral value adjustment), KVA (capital value adjustment) and MVA (margin value adjustment). OTC derivatives valuation is now critically dependent on those terms, now generally referred to as xVA. Hence, there is a need to fully define and discuss the world of xVA, taking into account the nature of the underlying market dynamics and new regulatory environment. This is the aim of this book"-- Provided by publisher