FVA Desk, the Effect of Funding

Abstract

In 2012, Hull and White published a paper in Risk Magazine [43] that shook the quantitative community in investment banks Since 2008, banks have suffered a notable increase in their funding costs, and hence derivative dealers have been calculating this cost and subtracting it from valuations of derivatives However, the theorists (i.e., Hull and White and those that share their view) refute this approach, since “it can create arbitrage opportunities”, and insist that funding should not be accounted for when pricing a derivative Furthermore, they say, a Funding Value Adjustment (FVA) carries double-counting with DVA, the “funding” side of CVA, and as a result the valuation of a bank’s balance sheet with bilateral CVA already accounts for the funding risk the firm has The practitioners have responded by asserting that they must account for the actual costs when valuing a trade, and funding is an important cost not fully captured in the ideal assumptions of bilateral CVA calculations.