Model Independent WWR for Regulatory CVA and for Accounting CVA and FVA

17 Pages Posted: 27 Mar 2020

See all articles by Chris Kenyon

Chris Kenyon

MUFG Securities EMEA plc

Mourad Berrahoui

Lloyds Banking Group

Benjamin Poncet

Lloyds Banking Group

Date Written: March 2, 2020

Abstract

Wrong way risk (WWR) is a consideration for regulatory capital for credit valuation adjustment (CVA). WWR is also of interest for pricing and accounting and in these cases must include funding as well as exposure and default in CVA and FVA calculation. Here we introduce a model independent approach to WWR for regulatory CVA and also for accounting CVA and FVA. This model independent approach is extremely simple: we just re-write the CVA and FVA integral expressions in terms of their components and then calibrate these components. This provides transparency between component calibration and CVA/FVA effect because there is no model interpretation in between. Including funding in WWR means that there are now two WWR terms rather than the usual one. Using a regulatory inspired calibration from MAR50 we investigate WWR effects for vanilla interest rate swaps and show that the WWR effects for FVA are significantly more material than for CVA. This model independent approach can also be used to compare any WWR model by simply calibrating to it for a portfolio and counterparty, to demonstrate the effects of the model under investigation in terms of components of CVA/FVA calculations.

Keywords: XVA, CVA, FVA, WWR, Accounting, Regulations, Capital, Funding, Default, Model Independent, Credit

JEL Classification: G11, G12, G13, G32, G33, E43, D81, D86, D52, C63, C61

Suggested Citation

Kenyon, Chris and Berrahoui, Mourad and Poncet, Benjamin, Model Independent WWR for Regulatory CVA and for Accounting CVA and FVA (March 2, 2020). Available at SSRN: https://ssrn.com/abstract=3547866 or http://dx.doi.org/10.2139/ssrn.3547866

Chris Kenyon (Contact Author)

MUFG Securities EMEA plc ( email )

25 Ropemaker St
London, EC2Y 9AJ
United Kingdom

Mourad Berrahoui

Lloyds Banking Group ( email )

10 Gresham Street
London, EC2V 7AE
United Kingdom

Benjamin Poncet

Lloyds Banking Group ( email )

10 Gresham Street
London, EC2V 7AE
United Kingdom

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