Aug 17, 2015

Demystifying the XVAs: DerivSource Podcast

With evolving regulations considered key drivers behind the new era of ‘real-time’ risk management, integrating pre-trade analysis into the front office and trading desk has taken on ever-increasing importance. The focus on front-to-back operational efficiency has resulted in the need for an integration of insights from risk management into trading decisions.

To adapt to all of the shifting regulations and requirements, the growing trend in the market has been toward embracing more integrated and holistic approaches for managing and calculating risk—along with a shifting focus towards optimizing business lines and trade activity. While some institutions are taking it one step at a time, larger banks and even buy-side institutions, depending on size and geography, are analyzing the entire range of XVA costs together to achieve what we call ‘risk-informed’ decisionmaking.

There’s no doubt about it. Understanding and managing trade profitability with a complete knowledge of all the costs associated with the trade lifecycle has become a critical need. One of the newest XVA adjustments under debate is Capital Valuation Adjustment (KVA).  Though not yet required by regulators, KVA is recognized as the cost of holding bank capital against the risk of a trade on all dates into the future. KVA in fact is much more complex than CVA, DVA, or even FVA because KVA corresponds to aggregation of future capital for different types of risk—spanning from market and counterparty credit risk to operational risk in the future. To add to the complexity, KVA can be computed in different ways, with many methodologies currently in existence, including those using complex simulations. And, even for capital (capital as of today and required by regulators) different calculation approaches are being used amongst market participants.

At the end-of-the day, with this growing list of XVA pricing adjustments—along with new regulations continuously being implemented and rolled-out—what should market practitioners be looking at when it comes down to navigating these complex computational and modeling challenges to achieve best practices and ultimate profitability?

To explore these concepts further, join DerivSource and Numerix SVP Satyam Kancharla for the DerivSource Podcast entitled “XVA Models.” The podcast examines the new risk management model for pricing adjustments, along with trends impacting other pricing models such as MVA and KVA.

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