The xVA Challenge. Gregory Jon

fear CVA charge will make hedging too expensive”, Risk, October 2011.

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1

This occurs when a large number of customers withdraw their deposits because they believe the bank is, or might become, insolvent.

2

AIG would receive further bailouts.

3

Hundreds of billions of pounds were provided in the form of loans and guarantees.

4

“Corporates fear CVA charge will make hedging too expensive”, Risk, October 2011.

5

See www.bankofengland.co.uk/publications/Documents/quarterlybulletin/qb1002.pdf.

6

Quote from 2002.

7

This is the process of determining the price of an asset in a marketplace through the interactions of buyers and sellers.

8

Source: ISDA survey, 1986, covering only swaps.

9

Source: ISDA market survey, 2010.

10

Meaning that the market priced their debt as being of very high quality and practically risk-free.

11

Aside from initial margin requirements and capital requirements.

12

Or via a central counterparty, or later reduced via trade compression.

13

For a continuous distribution, VAR is simply a quantile. (A quantile gives a value on a probability distribution where a given fraction of the probability falls below that level.)

14

Certain implementations of a VAR model (notably the so-called variance-covariance approach) may make normal (Gaussian) distribution assumptions, but these are done for reasons of simplification and the VAR idea itself does not require them.

15

Under the Basel III regulations.

16

On the basis that an individual unable to pay is likely to be close to any limit.

17

This is not precisely true in the case of bilateral counterparty risk (DVA), discussed in Chapter 14, although conventions regarding close-out amounts can correct for this.

18

A multi-currency cash settlement system – see www.cls-group.com.

19

Delivery versus payment, where payment is made at the moment of delivery, aiming to minimise settlement risk in securities transactions.

20

Except in some special and non-standard cases.

21

We will generally use the term “default” to refer to any “credit event” that could impact the counterparty.

22

Here we refer to default probabilities in a specified period, such as annual.

23

This can refer to a real expectation (historical) or one implied from market spreads (risk-neutral) as discussed below.

24

This means they have the same seniority and therefore should expect to receive the same recovery value.

25

For example, see “Consumers exceeding bank credit lines slows oil hedging”, Risk, 2nd April 2015.

26

Strictly speaking, it is a netting set level calculation, as there can possibly be more than one netting agreement with a given counterparty.