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1 – 10 of over 2000
Article
Publication date: 3 August 2015

Lixin Wu and Chonhong Li

The purpose of this paper is to provide a framework of replication pricing of derivatives and identify funding valuation adjustment (FVA) and credit valuation adjustments (CVA) as…

Abstract

Purpose

The purpose of this paper is to provide a framework of replication pricing of derivatives and identify funding valuation adjustment (FVA) and credit valuation adjustments (CVA) as price components.

Design/methodology/approach

The authors propose the notion of bilateral replication pricing. In the absence of funding cost, it reduces to unilateral replication pricing. The absence of funding costs, it introduces bid–ask spreads.

Findings

The valuation of CVA can be separated from that of FVA, so-called split up. There may be interdependence between FVA and the derivatives value, which then requires a recursive procedure for their numerical solution.

Research limitations/implications

The authors have assume deterministic interest rates, constant CDS rates and loss rates for the CDS. The authors have also not dealt with re-hypothecation risks.

Practical implications

The results of this paper allow user to identify CVA and FVA, and mark to market their derivatives trades according to the recent market standards.

Originality/value

For the first time, a line between the risk-neutral pricing measure and the funding risk premiums is drawn. Also, the notion of bilateral replication pricing extends the unilateral replication pricing.

Details

Studies in Economics and Finance, vol. 32 no. 3
Type: Research Article
ISSN: 1086-7376

Keywords

Article
Publication date: 13 July 2015

Mika Veli-Pekka Viljanen

– The purpose of this paper is to aid understanding of the changes in Basel Committee on Banking Supervision (BCBS) regulatory strategies after the global financial crisis.

Abstract

Purpose

The purpose of this paper is to aid understanding of the changes in Basel Committee on Banking Supervision (BCBS) regulatory strategies after the global financial crisis.

Design/methodology/approach

The author uses the credit valuation adjustment (CVA) charge reform as a test case for inquiring whether BCBS has departed from its pre-crisis facilitative regulatory strategy path. The regulatory strategy of the CVA charge is discussed.

Findings

The charge exhibits a new regulatory strategy that BCBS has adopted. It seeks to manipulate market structures by imposing risk-insensitive capital charge methodologies.

Originality/value

The paper offers a new heuristic to analyse regulatory initiatives and their significance. The CVA charge has not been subject to a regulatory theory-based analysis in prior literature.

Details

Journal of Financial Regulation and Compliance, vol. 23 no. 3
Type: Research Article
ISSN: 1358-1988

Keywords

Open Access
Article
Publication date: 14 July 2020

Mete Feridun and Alper Özün

Introducing radical changes to the methodologies for the determination of capital requirements, the final stage of the Basel III standards, which is referred to as “Basel IV” by…

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Abstract

Purpose

Introducing radical changes to the methodologies for the determination of capital requirements, the final stage of the Basel III standards, which is referred to as “Basel IV” by the industry, will be a significant challenge for the global banking sector. This article reviews the main components of the new framework, analyses its ongoing implementation in the European Union and discusses its potential impact on banks, putting forward policy recommendations.

Design/methodology/approach

This article uses primary sources such as the publications by the Basel Committee for Banking Supervision and the European Commission. It also reviews the secondary sources, including both academic articles and analyses by various stakeholders. However, this article does not undertake any empirical analysis.

Findings

This article discusses that Basel IV will introduce strategic, operational and regulatory challenges for banks in scope. It also identifies a number of areas which are subject to further debate in the European Union such as the enhanced due diligence requirements under the new credit risk framework; governance, reporting and control rules under the operational risk framework; exemptions for certain derivative transactions under the credit valuation adjustment framework and the level of application of the capital floors within banking groups. This article concludes that the global implementation of the reforms by all jurisdictions and transposition into national banking laws concurrently with the European Union in line with the Basel Committee's implementation timeline is important from a financial stability standpoint.

Originality/value

The article presents an up-to-date and comprehensive review of the practical implications of Basel IV standards. It analyses the implementation of the standards in the case of the European Union, reviews the potential policy implications and presents recommendations for risk management practitioners.

Details

Journal of Capital Markets Studies, vol. 4 no. 1
Type: Research Article
ISSN: 2514-4774

Keywords

Article
Publication date: 8 July 2014

Michael Jacobs Jr.

– This study aims to survey supervisory requirements and expectations for counterparty credit risk (CCR).

Abstract

Purpose

This study aims to survey supervisory requirements and expectations for counterparty credit risk (CCR).

Design/methodology/approach

In this paper, a survey of CCR including the following elements has been performed. First, various concepts in CCR measurement and management, including prevalent practices, definitions and conceptual issues have been introduced. Then, various supervisory requirements and expectations with respect to CCR have been summarized. This study has multiple areas of relevance and may be extended in various ways. Risk managers, traders and regulators may find this to be a valuable reference. Directions for future research could include empirical analysis, development of a theoretical framework and a comparative analysis of systems for analyzing and regulating CCR.

Findings

Some of the thoughts regarding the concept of risk will be considered and surveyed, and then how these apply to CCR will be considered. A classical dichotomy exists in the literature, the earliest exposition upon which is credited to Knight (1921), who defines uncertainty is when it is not possible to measure a probability distribution or it is unknown. This is contrasted with the situation where either the probability distribution is known, or knowable through repeated experimentation. Arguably, in economic and finance (and more broadly in the social or natural as opposed to the physical or mathematical sciences), the former is a more realistic scenario that is being contending with (e.g. a fair vs loaded die, or die with unknown number of sides.) The authors are forced to rely upon empirical data to estimate loss distributions, but this is complicated because of changing economic conditions, which invalidate forecasts that our econometric models generate.

Originality/value

This is one of few studies of the CCR regulations that is so far-reaching.

Details

Journal of Financial Regulation and Compliance, vol. 22 no. 3
Type: Research Article
ISSN: 1358-1988

Keywords

Article
Publication date: 9 February 2015

Lukasz Prorokowski and Hubert Prorokowski

This report aims to investigate the approaches taken by financial institution to implement and compute the funding valuation adjustment (FVA). FVA can be defined as the…

Abstract

Purpose

This report aims to investigate the approaches taken by financial institution to implement and compute the funding valuation adjustment (FVA). FVA can be defined as the incremental cost attributable to trades with non-collateralised counterparties. This cost emerges related to the need to fund the collateral calls associated with collateralised hedge trades. In this respect, one common challenge faced by banks relates to designing appropriate methodological approaches to compute an FVA.

Design/methodology/approach

Recognising the growing importance of an FVA, this report is designed to investigate different approaches to computing FVA and pricing funding costs into the uncollateralised positions. Embarking on semi-structured interviews, the report explores the methodologies and structural solutions utilised by global banks.

Findings

This report has indicated several influential trends that shape the nascent FVA landscape, as well as innovative initiatives undertaken by the banks to effectively use this metric. Going forward, this paper has pointed to a number of current and future challenges faced by the participating banks with regard to implementing the FVA.

Originality/value

Before regulators make FVA punitive, unprofitable or inadequate by propagating the move to collateralised trading or introducing sanctions on banks recognising FVA in their financial statements, and thus reducing banks’ exposure to arbitrage opportunities, FVA will remain a challenging metric for the banking industry in the near future. Therefore, it is pivotal to understand any potential risks and operational difficulties arising from “sailing on the uncharted waters with FVA”. Moreover, it is necessary to understand market consensus on methodological approaches to computing FVA, as well as practices around constructing the bank’s own cost of funds curves.

Details

Journal of Financial Regulation and Compliance, vol. 23 no. 1
Type: Research Article
ISSN: 1358-1988

Keywords

Abstract

Details

Understanding Financial Risk Management, Third Edition
Type: Book
ISBN: 978-1-83753-253-7

Abstract

Details

Understanding Financial Risk Management, Second Edition
Type: Book
ISBN: 978-1-78973-794-3

Article
Publication date: 8 November 2011

Robert C. Rickards and Rolf Ritsert

The purpose of this article is to analyze problems involved in using a four‐tiered, indirect sales‐and‐distribution (S&D) model and describe how a manufacturing small and…

2454

Abstract

Purpose

The purpose of this article is to analyze problems involved in using a four‐tiered, indirect sales‐and‐distribution (S&D) model and describe how a manufacturing small and medium‐sized enterprise's (SME's) controller can master them.

Design/methodology/approach

The approach taken is an in‐depth case study of an Asian SME selling its homeopathic remedies through European wholesalers and retailers to geographically dispersed consumers.

Findings

The case study provides four main conclusions. First, entering into an indirect S&D relationship with wholesalers and retailers is just one more step along the road to outsourcing an enterprise's non‐core functions in a global economy. Second, as long as an SME is on this road, its controller must make the best of the situation and master the resulting complexity in the areas of sales and distribution. Third, above all, integrating business partners' wholesale and retail trade data into the SME's own management information system represents a major technical challenge. Fourth, presenting a clear, complete, and multidimensional overview of sales figures and inventory levels is a task likely to demand more time and attention in the future.

Research limitations/implications

The research methodology employed here is descriptive, not explanatory. Because the study observes just one firm, it may not be representative of the general SME population. Moreover, much of the information collected is retrospective data and recollections of past events, which may be subject to problems inherent with memory or inadequate recordkeeping. Nevertheless, the findings form a foundation for better understanding the use of a four‐tiered, indirect S&D model.

Originality/value

While much of the literature explicitly or implicitly assumes use of direct S&D models, this article specifically addresses problems arising from an SME's employment of an indirect model and its loss of direct contact with consumers.

Details

International Journal of Retail & Distribution Management, vol. 39 no. 12
Type: Research Article
ISSN: 0959-0552

Keywords

Article
Publication date: 15 July 2019

Min Xu, Hong Xie and Yuehua Wu

The purpose of this paper is to analyze different behaviors between long-term options’ implied volatilities and realized volatilities.

Abstract

Purpose

The purpose of this paper is to analyze different behaviors between long-term options’ implied volatilities and realized volatilities.

Design/methodology/approach

This paper uses a widely adopted short interest rate model that describes a stochastic process of the short interest rate to capture interest rate risk. Price a long-term option by a system of two stochastic processes to capture both underlying asset and interest rate volatilities. Model capital charges according to the Basel III regulatory specified approach. S&P 500 index and relevant data are used to illustrate how the proposed model works. Coup with the low interest rate scenario by first choosing an optimal time segment obtained by a multiple change-point detection method, and then using the data from the chosen time segment to estimate the CIR model parameters, and finally obtaining the final option price by incorporating the capital charge costs.

Findings

Monotonic increase in long-term option implied volatility can be explained mainly by interest rate risk, and the level of implied volatility can be explained by various valuation adjustments, particularly risk capital costs, which differ from existing published literatures that typically explained the differences in behaviors of long-term implied volatilities by the volatility of volatility or risk premium. The empirical results well explain long-term volatility behaviors.

Research limitations/implications

The authors only consider the market risk capital in this paper for demonstration purpose. Dealers may price the long-term options with the credit risk. It appears that other than the market risks such as underlying asset volatility and interest rate volatility, the market risk capital is a main nonmarket risk factor that significantly affects the long-term option prices.

Practical implications

Analysis helps readers and/or users of long-term options to understand why long-term option implied equity volatilities are much higher than observed. The framework offered in the paper provides some guidance if one would like to check if a long-term option is priced reasonable.

Originality/value

It is the first time to analyze mathematically long-term options’ volatility behavior in comparison with historically observed volatility.

Details

Studies in Economics and Finance, vol. 38 no. 3
Type: Research Article
ISSN: 1086-7376

Keywords

Content available
Book part
Publication date: 12 June 2024

Abstract

Details

Professional Perspectives on Banking and Finance, Volume 1
Type: Book
ISBN: 978-1-83549-335-9

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