Beyond Valuation Adjustments: an Indifference Approach to Funding and Capital

In the recent years the rise of funding costs and the strengthening of capital requirements induced banks and traders to consider to charge a so called funding valuation adjustment (FVA) and capital valuation adjustment (KVA)... [ view full abstract ]

In the recent years the rise of funding costs and the strengthening of capital requirements induced banks and traders to consider to charge a so called funding valuation adjustment (FVA) and capital valuation adjustment (KVA) to their clients in OTC transactions. Using an indifference pricing approach we show that this roughly corresponds to charge the clients ex ante an amount that makes the deal profitable for the different stakeholders of the bank. Finally we reconcile this view with the usual non arbitrage framework used in the literature on valuation adjustments.