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Funding Value Adjustments

61 Pages Posted: 13 Mar 2016 Last revised: 2 Aug 2017

Leif B. G. Andersen

Bank of America Merrill Lynch

Darrell Duffie

Stanford University - Graduate School of Business; National Bureau of Economic Research (NBER)

Yang Song

Stanford University, Graduate School of Business, Students

Multiple version iconThere are 2 versions of this paper

Date Written: August 1, 2017

Abstract

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

Andersen, Leif B. G. and Duffie, Darrell and Song, Yang, Funding Value Adjustments (August 1, 2017). Available at SSRN: https://ssrn.com/abstract=2746010

Leif B.G. Andersen

Bank of America Merrill Lynch ( email )

One Bryant Park
New York, NY 10036
United States
646-855-1835 (Phone)

James Darrell Duffie (Contact Author)

Stanford University - Graduate School of Business ( email )

655 Knight Way
Knight Management Center
Stanford, CA 94305-7298
United States
650-723-1976 (Phone)
650-725-8916 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Yang Song

Stanford University, Graduate School of Business, Students ( email )

655 Knight Management Way
Stanford, CA 94305
United States

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