Working Paper: NBER ID: w23680
Authors: Leif Andersen; Darrell Duffie; Yang Song
Abstract: We demonstrate that the funding value adjustments (FVAs) of major dealers are debt-overhang costs to their shareholders. In order to maximize shareholder value, dealer quotations therefore adjust for FVAs. Our case examples include interest-rate swap FVAs and violations of covered interest parity. Contrary to current valuation practice, FVAs are not themselves components of the market values of the positions being financed. Current dealer practice does, however, align incentives between trading desks and shareholders. We also establish a pecking order for preferred asset financing strategies and provide a new interpretation of the standard debit value adjustment (DVA).
Keywords: No keywords provided
JEL Codes: G12; G23; G24; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Funding Value Adjustments (FVAs) (G32) | debt-overhang costs to shareholders (G32) |
| dealer's pricing strategies (L11) | costs borne by shareholders (G34) |
| dealer's pricing strategies (L11) | equity value (D46) |
| magnitude of CIP violations (K42) | shareholder benefits from arbitraging discrepancies (G19) |
| Funding Value Adjustments (FVAs) (G32) | market value of swaps (G19) |