Funding Value Adjustments

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

March 10, 2016

We demonstrate that large funding value adjustments (FVAs) being made by derivatives dealers to the disclosed valuations of their swap books are not consistent with any coherent notion of fair market value. Essentially the same funding cost adjustment is a reduction in the dealer's equity value. This reduction in equity value is exactly offset by the sum of an upward adjustment to a dealer's debt valuation (as a wealth transfer from shareholders) and a change in the present value of the dealer's financial distress costs. While others have already suggested that FVA accounting suffers from coherence problems, this paper is the first to identify and characterize these problems in the context of a full structural model of a dealer's balance sheet. In addition to giving an appropriate theoretical foundation for funding value adjustments, our model shows how dealers' bid and ask quotes should be adjusted so as to compensate shareholders for the impact of both funding costs and the dealer's own default risk. We also establish a pecking order for preferred swap financing strategies, characterize the valuation effects of initial margin financing (known as "MVA"), and provide a new interpretation of the standard debit value adjustment (DVA).

Number of Pages in PDF File: 53

Keywords: Funding value adjustment, swap XVAs, debit value adjustment, debt overhang

JEL Classification: G12, G20

Open PDF in Browser Download This Paper

Date posted: March 13, 2016  

Suggested Citation

Andersen, Leif B. G. and Duffie, Darrell and Song, Yang, Funding Value Adjustments (March 10, 2016). Available at SSRN: https://ssrn.com/abstract=2746010

Contact Information

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
Feedback to SSRN

Paper statistics
Abstract Views: 2,728
Downloads: 797
Download Rank: 22,718