Module 16 · Advanced
The XVA family
Textbook models give a derivative one clean, risk-free price. The real world charges for everything that clean price ignores — a whole stack of valuation adjustments, collectively XVA. CVA (last module) is just the first:
- CVA — the cost that your counterparty might default (a charge).
- DVA — the mirror: that you might default. Counts as a benefit — controversially, you “gain” from your own credit risk.
- FVA — the cost of funding an uncollateralized position on your balance sheet.
- MVA — the cost of funding the initial margin you must post.
- KVA — the cost of holding regulatory capital against the trade over its life.
Add them up and a “fair value” of zero can cost the bank real money — so it's built into the price you're quoted. Computing XVA across an entire trading book (millions of trades, thousands of simulated paths, netting sets, collateral) is one of the largest and most compute-heavy jobs on a modern derivatives desk. Size each one below and watch the all-in cost.
🎛 XVA waterfall
A textbook “fair value” of $0 on this swap really costs the bank -$130,000once every adjustment is counted — so that's baked into the price you're quoted.
Classical pricing gives a derivative one clean value. Reality adds a stack of valuation adjustments (XVA): CVA (counterparty default), DVA(our own default — a controversial “benefit”), FVA (funding the position), MVA (funding initial margin), and KVA (holding regulatory capital). Together they can move a price by basis points to percent, and computing them across a whole trading book is one of the biggest jobs on a modern derivatives desk. Educational tool — not investment advice.
So where does the money actually come from?
XVA looks like pure cost — so how does anyone profit from it? The trick is that XVA prices scarce resources: counterparty credit, funding, capital and margin. Whoever holds those resources cheapest captures the spread.
- A bank charges the client the full market XVA, but funds and hedges it cheaper than it charges (its edge), adds a bid-offer markup, and keeps DVA as a paper benefit. KVA is largely pass-through — it just earns its hurdle on the capital.
- The other big source is XVA release: novating a trade to clearing, compressing offsetting trades, or optimising collateral shrinks the reserved XVA — and that release is booked as real P&L.
- A hedge fund plays the mirror image: unconstrained by bank capital rules (no KVA), it holds the risk banks are regulated out of, and trades the market basis (CDS-bond, cross-currency, collateral) that bank XVA-hedging distorts.
Size a trade below, then watch the desk's margin — and hit “clearing” or “compress” to book a release.
🎛 XVA money-map — where the desk's P&L comes from
The trade — an uncollateralised swap vs. a corporate
The quoted price, split by adjustment — total $1,298,500 (130bp)
CVA
$367,500
counterparty credit
FVA
$147,000
funding the exposure
MVA
$84,000
funding initial margin
KVA
$700,000
regulatory capital
DVA
+$220,500
own-credit benefit
How the desk makes money
The client is charged the full market XVA. The desk holds the credit & funding resources cheaper than it charges (its edge), adds a markup, and keeps the DVA as a paper benefit.
Charged to client
$1,378,500
XVA + markup
Desk's true cost
$1,141,000
hedge + fund + capital
Day-1 margin
$237,500
24% on capital
Retained DVA
$220,500
paper — can't spend it
XVA release — monetising a trade that gets cheaper
Shrink the resources the trade consumes and the reserve you already booked is released as P&L. This is where a lot of real desk revenue comes from.
A bank earns the gap between the XVA it charges and its own cheaper cost of credit, funding and capital — plus every optimisation (clearing, compression, novation, collateral) that shrinks the reserve. A fund plays the other side: unconstrained by capital rules, it holds the risk banks are regulated out of and trades the basis their XVA hedging creates. Educational tool — not investment advice.
Things to try
- • Turn every adjustment to zero, then add them one at a time — see how the “fair” price drifts away from clean.
- • Notice DVA is the only green (positive) one — the accounting benefit of your own default risk.
- • Scale the notional up — a few basis points of XVA becomes a very large dollar number.