Risky Funding: A unified framework for counterparty and liquidity charges
by Massimo Morini of Banca IMI, and
August 30, 2010
Abstract: Standard techniques for incorporating liquidity costs into the fair value of derivatives produce counter-intuitive results when credit risk of the counterparty (CVA) and of the investor (DVA) are added to the picture. Here, Massimo Morini and Andrea Prampolini show that a consistent framework can only be achieved by giving an explicit representation to the funding strategy, including associated default risks.
Keywords: counterparty risk, CVA, DVA, funding, liquidity, bond-CDS basis.