Managing Funding Valuation Adjustment and Funding Risk

Summary

This document raises the challenge of managing funding valuation adjustment (FVA) in a bank treasury. It describes a common calculation at a high level: forecast a funding profile and apply a funding spread. Hedging that expected profile with assets or liabilities can leave the institution exposed when realized funding needs differ from the forecast.

The central issue is how banks handle this residual liquidity risk when dynamic hedging is impractical in less liquid markets. The discussion also asks how desk-level charges translate into treasury liquidity management and whether similar considerations apply to other valuation adjustments, such as KVA. It presents no answer, institutional practice, quantitative evidence, or specific hedge. As a result, it frames an open risk-management question rather than teaching a settled methodology.

Key ideas

• FVA calculations are described as applying a funding spread to a projected funding profile.
• Hedging expected funding needs can leave exposure when the realized profile changes.
• Dynamic hedging may be difficult when liquidity is limited.
• The document asks how banks allocate and manage the resulting liquidity risk.
• It raises KVA as another valuation adjustment whose management may require consideration.

Tags

# Hedging XVA sensitivities and funding risk


# Hedging XVA sensitivities and funding risk












FVA is a hot topic today and I've been thinking on how its managed inside a treasury department.

Although the pricing/calculation is well covered in academic material and there is some sort of consesud in the methodology (generate some funding profile and apply some funding spread), the management and hedging is not well understood.

For example, if we generate a an expected funding profile and hedge the funding risk with assets/libabilities, we are still open to the fluctuations in the profile, meaning that we would require extra/less funding that what we projected and dynamic hedging aren't feasible in liquidity markets.

How is this adjustment usually managed in banks? I'm clear that i might be charged to dealing desk, but after that, how liquidity is managed? What about the other xva components like KVA?

Thanks!

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.