Credit (CVA), Debit (DVA) and Funding Valuation Adjustments (FVA) are now familiar valuation adjustments made to the value of a portfolio of derivatives to account for credit risks and funding costs. However, recent changes in the regulatory regime and the increases in regulatory capital requirements has led many banks to include the cost of capital in derivative pricing. This paper formalises the addition of cost of capital by extending the Burgard-Kjaer  semi-replication approach to CVA and FVA to include an addition capital term, Capital Valuation Adjustment (KVA, i.e. Kapital Valuation Adjustment to distinguish from CVA . Two approaches are considered, one where the (regulatory) capital is released back to shareholders upon counterparty default and one where the capital can be used to offset losses in the event of counterparty default  . The use of the semi-replication approach means that the flexibility around the treatment of self-default is carried over into this analysis. The paper further considers the practical calculation of KVA with reference to the Basel II (BCBS-128) and Basel III (BCBS-189) Capital regimes and its implementation via CRD IV (CRD-IV-Regulation,CRD-IV-Directive) . The paper assesses how KVA may be hedged, given that any hedging transactions themselves would lead to regulatory capital requirements and hence KVA. To conclude, a number of numerical examples are presented to gauge the cost impact of KVA on vanilla derivative products.
Credit (CVA), Debit (DVA) and Funding Valuation Adjustments (FVA) are now familiar valuation adjustments made to the value of a portfolio of derivatives to account for credit risks and funding costs. However, recent changes in the regulatory regime and the increases in regulatory capital requirements has led many banks to include the cost of capital in derivative pricing. This paper formalises the addition of cost of capital by extending the Burgard-Kjaer (2013) semi-replication approach to CVA and FVA to include an addition capital term, Capital Valuation Adjustment (KVA, i.e. Kapital Valuation Adjustment to distinguish from CVA ). The utilization of the capital for funding purposes and to offset losses in the event of counterparty default are considered . The use of the semi-replication approach means that the flexibility around the treatment of self-default is carried over into this analysis. The paper further considers the practical calculation of KVA with reference to the Basel II and Basel III capital regimes and their implementation via CRD IV . The paper assesses how KVA may be hedged, given that any hedging transactions themselves lead to regulatory capital requirements and hence KVA. Finally a number of numerical examples are presented to gauge the cost impact of KVA on vanilla derivative products.
A
(2013)
R
. Two approaches are considered, one where the (regulatory) capital is released back to shareholders upon counterparty default and one where the capital can be used
). The utilization of the capital for funding purposes and
A
are considered
D
(BCBS-128)
R
(BCBS-189) Capital regimes and its
capital regimes and their
D
(CRD-IV-Regulation,CRD-IV-Directive)
D
would
R
To conclude,
Finally