Handling model risk with XVAs

2022/05/24 by Bénézet, Cyril, Crépey, Stéphane · 3 citations
#Computational Finance (q-fin.CP) #FOS: Economics and business #FOS: Mathematics #Pricing of Securities (q-fin.PR) #Probability (math.PR)

paper · doi:10.48550/arxiv.2205.11834

Abstract

In this paper we revisit Burnett (2021) & Burnett and Williams (2021)'s notion of hedging valuation adjustment (HVA), originally intended to deal with dynamic hedging frictions such as transaction costs, in the direction of model risk. The corresponding HVA reconciles a global fair valuation model with the local models used by the different desks of the bank. Model risk and dynamic hedging frictions indeed deserve a reserve, but a risk-adjusted one, so not only an HVA, but also a contribution to the KVA of the bank. The orders of magnitude of the effects involved suggest that local models should not so much be managed via reserves, as excluded altogether.

Cited by

• Robust Hedging Valuation Adjustment for Deep Hedging Policies under Market Frictions
• Monte Carlo on a single sample
• Robust Hedging Valuation Adjustment under Liquidity--Demand Stress

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