ABSTRACT
The xVA contains a growing list of valuation adjustments (VA): credit valuation adjustment (CVA), debit valuation adjustment (DVA), funding valuation adjustment (FVA), funding cost adjustment, collateral valuation adjustment, margin valuation adjustment, capital valuation adjustment, and etc. This chapter discusses the notions of CVA, DVA and FVA and derive the formulae for the rest of xVA as the expected present values of excessive cash flows due to funding spreads under the risk-neutral pricing measure. For better risk management, the chapter suggests the adoption of other established risk metrics, like the VaR or CVaR, by making use of and through Monte Carlo simulations under the real-world measure. The chapter describes the risk-neutral pricing measure and then uncover the corresponding hedging or replicating strategies against the market risks and the counterparty default risks. It shows that the market funding risk premium for unsecured lending and borrowing can be bilaterally priced into derivatives trades, without causing price asymmetry.
