XVA, or Valuation Adjustment, refers to a series of adjustments made in derivative pricing to account for various risks and costs that are not captured by traditional pricing methods. It encompasses a range of adjustments including Credit Valuation Adjustment (CVA), Debit Valuation Adjustment (DVA), Funding Valuation Adjustment (FVA), Capital Valuation Adjustment (KVA), and Margin Valuation Adjustment (MVA), among others.
XVA is used primarily by financial institutions engaged in trading and dealing with derivatives. It represents a more holistic approach to valuing derivatives, considering factors that affect the profitability and risk of these financial instruments beyond their market value.
XVA implementation is requiring an operating model change to traditional front-office trading operations, and significant investment in IT infrastructure is required to assist Finance, Risk, and Operations functions with the change.
PwC Australia
In Simpler Terms
Let’s say you’re selling custom-made bicycles. The price you set isn’t just based on the cost of materials and labor; you also consider other factors like the risk of a customer canceling the order at the last minute (CVA), the cost of financing the bike parts (FVA), and even the potential discounts for loyal customers (DVA). In the world of finance, XVA works similarly for derivatives. It’s about fine-tuning the price to account for various risks and costs that go beyond the basic value of the product.
