Given the limited CDS market it is inevitable that CVA desks will partially warehouse credit risk . Thus realistic CVA pricing must include both warehoused and hedged risks. Furthermore, warehoused risks may produce profits and losses which will be taxable. Paying for capital use, will also generate potentially taxable profitswith which to pay shareholder dividends. Here we extend the semi-replication approach in ( Burgard and Kjaer  2013) to include partial risk warehousing and tax consequences. In doing so we introduce double-semi-replication, i.e. partial hedging of value jump on counterparty default, and TVA : Tax Valuation Adjustment . We take an expectation approach to hedging open risk and so introduce a market price of counterparty default value jump risk. We show that both risk warehousing and tax are material in a set of interest rate swap examples .
Credit risk may be warehoused by choice, or because of limited hedging possibilities. Credit risk warehousing increases capital requirements and leaves open risk. Open risk must be priced in the physical measure, rather than the risk neutral measure, and implies profits and losses . Furthermore the rate of return on capital that shareholders require must be paid from profits. Profits are taxable and losses provide tax credits. Here we extend the semi-replication approach of Burgard and Kjaer ( 2013) and the capital formalism (KVA) of Green, Kenyon, and Dennis (2014) to cover credit risk warehousing and tax , formalized as double-semi-replication and TVA ( Tax Valuation Adjustment ) to enable quantification .
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Given the limited CDS market it is inevitable that CVA desks will partially warehouse credit risk . Thus realistic CVA pricing must include both warehoused and hedged risks. Furthermore, warehoused risks may produce
Credit risk may be warehoused by choice, or because of limited hedging possibilities. Credit risk warehousing increases capital requirements and leaves open risk. Open risk must be priced in the physical measure, rather than the risk neutral measure, and implies
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which will be taxable. Paying for capital use, will also generate potentially taxable profitswith which to pay shareholder dividends.
. Furthermore the rate of return on capital that shareholders require must be paid from profits. Profits are taxable and losses provide tax credits.
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in (
of
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(
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to include partial
and the capital formalism (KVA) of Green, Kenyon, and Dennis (2014) to cover credit
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consequences. In doing so we introduce double-semi-replication, i.e. partial hedging of value jump on counterparty default, and TVA :
, formalized as double-semi-replication and TVA (
R
. We take an expectation approach to hedging open risk and so introduce a market price of counterparty default value jump risk. We show that both risk warehousing and tax are material in a set of interest rate swap examples
) to enable quantification