61 Pages Posted: 13 Mar 2016 Last revised: 2 Aug 2017
Date Written: August 1, 2017
We demonstrate that the funding value adjustments (FVAs) of major dealers are debt-overhang costs to their shareholders. In order to maximize shareholder value, dealer quotations therefore adjust for FVAs. Contrary to current valuation practice, FVAs are not themselves components of the market values of the positions being financed. The current dealer practice of reducing the computed market values of their positions by FVAs does, however, align incentives between trading desks and shareholders. While others have already suggested that the market values of swaps do not actually include an FVA component, this is the first paper to identify and characterize the true nature of FVA with a structural model of a dealer's balance sheet. We also establish a pecking order for preferred asset financing strategies and provide a new interpretation of the standard debit value adjustment (DVA).
Keywords: Funding value adjustment, swap XVAs, debit value adjustment, debt overhang
JEL Classification: G12, G23, G24, G32
Suggested Citation: Suggested Citation
Andersen, Leif B. G. and Duffie, Darrell and Song, Yang, Funding Value Adjustments (August 1, 2017). Available at SSRN: https://ssrn.com/abstract=2746010