Funding Adjustments in Equity Linear Products

Abstract

Valuation adjustments are nowadays a common practice to include credit and liquidity effects in option pricing. Funding costs arising from collateral procedures, hedging strategies and taxes are added to option prices to take into account the production cost of financial contracts so that a profitability analysis can be reliably assessed. In particular, when dealing with linear products, we need a precise evaluation of such contributions since bid-ask spreads may be very tight. In this paper we start from a general pricing framework inclusive of valuation adjustments to derive simple evaluation formulae for the relevant case of total return equity swaps when stock lending and borrowing is adopted as hedging strategy.

Keywords: Funding, Valuation Adjustments, FVA, Collateral, Equity Swap, Total Return Swap, Stock Lending, Dividend Tax, Tobin Tax

JEL Classification: G12, G13, G32