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| Type | Master's Thesis |
| Scope | Discipline-based scholarship |
| Title | XVAs and their impact on the pricing of derivatives |
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| Institution | University of Zurich |
| Faculty | Faculty of Business, Economics and Informatics |
| Number of Pages | 115 |
| Date | 2020 |
| Abstract Text | XVAs represent a group of valuation adjustments that are calculated on top of the fair value of derivatives in order to account for various costs associated with derivatives business. (Gregory 2015, 2) The increasing use of XVAs has accumulated to a value in the magnitude of several billion USD over the last decade and XVAs have become a topic of controversial discussions across the industry. (PwC 2015, 2-3) This thesis examines the rationale linked to the use of XVAs and provides practical examples of XVA pricing on a sample portfolio of derivatives with the objective to assess the materiality of XVA adjustments. The XVAs that are analysed in detail include CVA, DVA, KVA and FVA. The portfolio consists of three one-year instruments, a forward, call and put option and two 7-year instruments including interest rate swap and cross currency swap. The necessary inputs into the XVA calculations including exposure profiles are simulated using Monte Carlo simulation using 100 000 iterations. The evolution of the simulated input variables is assumed to follow Brownian motion for the majority of instruments. It is shown that the materiality varies for each derivative with higher XVA values observed for instruments with longer maturity. The relative magnitude of XVAs differs with CVA being the most material adjustment in case of interest rate swap while FVA playing the most important role for derivatives with only one-sided positive exposure profiles such as options. Since the materiality of XVAs directly depends on the assumptions regarding value of calculation parameters, several input variables including credit quality and funding spread are subject to stress testing. Three stress scenarios of various severity are applied to the derivatives in the sample portfolio showing that the size of XVAs can fluctuate dramatically in times of stress, multiplying to several times the original value. The results indicate that the values of XVAs are far from negligible as they have the potential to grow and lead to high losses, especially for institutions with large portfolios of uncollateralised derivatives. |
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