Author(s)

R. Abbate

SunGard.

Banks are subject to higher capital charges for transactions that are uncollateralized and typically incorporate the cost of counterparty credit risk into the prices of derivative contracts quoted to commercial end-users. Many banks have adopted a framework under which they incorporate the cost of funding and liquidity into the risk-neutral price of uncollateralized derivative contracts. The Law of One Price no longer holds, as the inclusion of credit risk and funding results in different banks quoting inconsistent prices for the same transaction. The purpose of this paper is to outline and quantify the effects of counterparty credit risk, one’s own credit risk and funding costs on the pricing of uncollateralized financial derivative contracts. We examine Credit Valuation Adjustment (CVA), Debit Valuation Adjustment (DVA) and Funding Valuation Adjustment (FVA).

Credit Valuation Adjustment (CVA), Debit Valuation Adjustment (DVA), Funding Valuation Adjustment (FVA), Potential Future Exposure (PFE), Uncollateralized Derivatives Pricing

Abbate, R. (2015) The Effects of Credit Risk and Funding on the Pricing of Uncollateralized Derivative Contracts. Journal of Financial Risk Management, 4, 57-71. doi: 10.4236/jfrm.2015.42006.