In the aftermath of the 2007/2008 global financial crisis, financial institutions have shifted their focus to more actively manage the risks associated with over-the-counter (OTC) contracts. It is now standard practice to adjust derivative prices for the risk of the counterparty’s or one’s own default, by means of credit or debit valuation adjustments (CVA/DVA). Further, the cost of funding a trade has increased significantly after the crisis, as banks can no longer borrow money at the risk-free rate. This cost is accommodated for by the funding valuation adjustment (FVA). More such adjustments are in use in practice, for example for the cost of regulatory capital (KVA) or for initial margin funding costs (MVA). All these adjustments are commonly referred to as XVA.
This white paper gives an overview of the different XVA adjustments, shows how they are computed, and outlines where the computational challenges lie. It then details specific software optimisations and gives practical hints on how to cope with the computational complexities.