Behavioural XVA

Behavioural effects in XVA occur in the typical case of hedging a client trade: on client default the hedge (effects) will be removed, alternatively if the hedge counterparty defaults the hedge will be replaced. Thus the... [ view full abstract ]

Behavioural effects in XVA occur in the typical case of hedging a client trade: on client default the hedge (effects) will be removed, alternatively if the hedge counterparty defaults the hedge will be replaced. Thus the default probability driving MVA hedge costs, for example, is from the client not the hedge counterparty. This breaks the usual assumption that counterparty XVAs can be computed independently of each other.  For another example on the hedge side, multiple CVA costs should be included as replacement hedge counterparties can also default.  Numerical examples demonstrate that client XVA prices ignoring behaviour can be materially incorrect.