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MVA Transfer Pricing

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  • Wujiang Lou

Abstract

This article prices OTC derivatives with either an exogenously determined initial margin profile or endogenously approximated initial margin. In the former case, margin valuation adjustment (MVA) is defined as the liability-side discounted expected margin profile, while in the latter, an extended partial differential equation is derived and solved for an all-in fair value, decomposable into coherent CVA, FVA and MVA. For uncollateralized customer trades, MVA can be transferred to the customer via an extension of the liability-side pricing theory. For BCBS-IOSCO covered OTC derivatives, a market maker has to charge financial counterparties a bid-ask spread to transfer its funding cost. An IM multiplier is applied to calibrate to external IM models to allow portfolio incremental pricing. In particular, a link to ISDA SIMM for equity, commodity and fx risks is established through the PDE with its vega and curvature IM components captured fully. Numerical examples are given for swaps and equity portfolios and offer a plausible attribution of recent CME-LCH basis spread widening to elevated MVA accompanying dealers' hedging of customer flows.

Suggested Citation

  • Wujiang Lou, 2015. "MVA Transfer Pricing," Papers 1512.07337, arXiv.org, revised Jul 2016.
    • Handle: RePEc:arx:papers:1512.07337
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    References listed on IDEAS

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    1. Andrew Green & Chris Kenyon, 2014. "MVA: Initial Margin Valuation Adjustment by Replication and Regression," Papers 1405.0508, arXiv.org, revised Jan 2015.
    2. Wujiang Lou, 2015. "Liability-side Pricing of Swaps and Coherent CVA and FVA by Regression/Simulation," Papers 1512.07340, arXiv.org.
    3. Wujiang Lou, 2015. "Coherent CVA and FVA with Liability Side Pricing of Derivatives," Papers 1510.07199, arXiv.org.
    4. Damiano Brigo & Andrea Pallavicini, 2014. "Nonlinear consistent valuation of CCP cleared or CSA bilateral trades with initial margins under credit, funding and wrong-way risks," Journal of Financial Engineering (JFE), World Scientific Publishing Co. Pte. Ltd., vol. 1(01), pages 1-60.
    5. Damiano Brigo & Andrea Pallavicini, 2014. "CCP Cleared or Bilateral CSA Trades with Initial/Variation Margins under credit, funding and wrong-way risks: A Unified Valuation Approach," Papers 1401.3994, arXiv.org.
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