Wednesday, September 1, 2010

Risky Funding: A unified framework for counterparty and liquidity charges

By Massimo Morini and Andrea Prampolini of Banca IMI

Abstract: Standard techniques for incorporating liquidity costs into the fair value of derivatives produce counter-intuitive results when credit risk of the counterparty (CVA) and of the investor (DVA) are added to the picture. Here, Massimo Morini and Andrea Prampolini show that a consistent framework can only be achieved by giving an explicit representation to the funding strategy, including associated default risks.

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