Hedging Valuation Adjustment: Fact and friction

Risk Magazine, February 2021

14 Pages Posted: 27 Nov 2020 Last revised: 22 Feb 2021

Date Written: October 11, 2020

Abstract

We develop a simple and generic expression for the impact of transaction costs on the value of a derivative portfolio, expressed as a 'Hedging Valuation Adjustment' (HVA). We provide expressions for the HVA in two cases: when it is included as part of the value to be hedged, and when it is left as an unhedged reserve. The hedged case shows an interesting feature we term 'imaginary volatility'. We show numerical results, and extend the formalism to the pricing of individual trades and to the multi-asset case.

Keywords: XVA, CVA, FVA, MVA, Friction, Transaction costs, Hedging, Incomplete Markets, Derivatives, Valuation

JEL Classification: D23, G12, G13

Suggested Citation

Burnett, Benedict, Hedging Valuation Adjustment: Fact and friction (October 11, 2020). Risk Magazine, February 2021, Available at SSRN: https://ssrn.com/abstract=3709477 or http://dx.doi.org/10.2139/ssrn.3709477

Benedict Burnett (Contact Author)

Barclays Investment Bank ( email )

5 The North Colonnade
London, Canary Wharf E14 4BB
United Kingdom

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