xVA is a collective term for various valuation adjustments applied to derivatives transactions, extending beyond traditional fair value to account for funding, credit, debit, and other counterparty-related risks. Its purpose is to provide a more accurate and comprehensive measure of a derivative’s true cost or value.
Mechanism
Its components and calculation include Credit Valuation Adjustment (CVA) for counterparty default risk, Debt Valuation Adjustment (DVA) for own default risk, Funding Valuation Adjustment (FVA) for funding costs, and Capital Valuation Adjustment (KVA) for regulatory capital costs. These adjustments are complex, typically calculated using Monte Carlo simulations that project future exposures and probabilities of default, crucial for OTC crypto derivatives.
Methodology
The strategic principles provide a holistic risk-adjusted valuation framework, ensuring that the full economic cost of derivatives is captured. It influences pricing, collateral management, and risk appetite decisions, becoming particularly relevant in the institutional crypto derivatives space where counterparty risk and funding considerations can be significant, demanding precise capital and risk management.
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