Funding Value Adjustments

Funding Value Adjustments

By
Darrell Duffie, Leif Andersen, Yang Song
Journal of Finance, forthcoming.
2017

We demonstrate that the funding value adjustments (FVAs) of major dealers are debtoverhang costs to their shareholders. In order to maximize shareholder value, dealer quotations therefore adjust for FVAs. Contrary to current valuation practice, FVAs are not themselves components of the market values of the positions being financed. The current dealer practice of reducing the computed market values of their positions by FVAs does, however, align incentives between trading desks and shareholders. While others have already suggested that the market values of swaps do not actually include an FVA component, this is the first paper to identify and characterize the true nature of FVA with a structural model of a dealer’s balance sheet. We also establish a pecking order for preferred asset financing strategies and provide a new interpretation of the standard debit value adjustment (DVA).