Hedging Valuation Adjustment and Model Risk

Claudio Albanese (1) , Cyril Bénézet (2, 3) , Stéphane Crépey (4, 5)

1 Global Valuation
2 LaMME - Laboratoire de Mathématiques et Modélisation d'Evry
3 ENSIIE - Ecole Nationale Supérieure d'Informatique pour l'Industrie et l'Entreprise
4 LPSM (UMR_8001) - Laboratoire de Probabilités, Statistique et Modélisation
5 UPCité - Université Paris Cité

We revisit Burnett (2021b,a)'s notion of hedging valuation adjustment (HVA) in the direction of model risk. The resulting HVA can be seen as the bridge between a global fair valuation model and the local models used by the different desks of the bank. However, model risk and dynamic hedging frictions, such as transaction costs à la Burnett (2021b,a), indeed deserve a reserve, but a risk-adjusted one, so not only an HVA, but also a contribution to the KVA of the bank. We also argue that the industry-standard XVA metrics are jeopardized by cash flows risk, which is in fact of the same mathematical nature than the one regarding pricing models, although at the higher level of aggregation characteristic of XVA metrics.

Domains: Computational Finance [q-fin.CP]; Probability [math.PR]

Claudio Albanese, Cyril Bénézet, Stéphane Crépey. Hedging Valuation Adjustment and Model Risk. 2022. ⟨hal-03675291v1⟩