CVA, FVA (and DVA?) with Stochastic Spreads: A feasible replication approach under realistic assumptions
by Luis Manuel García Muñoz of BBVA
February 23, 2013
Abstract: In this paper we explore the components that should be incorporated in the price of an uncolateralized derivative. We assume that one counterparty will act as the derivatives hedger while the other will act as the investor. Therefore, the derivative's price will reflect the replication costs from the hedger's perspective, which will not be equal to the replication price from the investor's perspective. We will also assume that the hedger only has the incentive to hedge the changes in value that the derivative experiences while the hedger remains not defaulted. We assume that both the investor's and the hedger's credit curves are stochastic, so that the hedger is not only concerned with the default event of the investor (but not of his own), but also with spread changes of both counterparties.
Keywords: CVA, DVA, FVA, Collateral, Full replication,.