DVA for Assets

TL;DR

This paper explores the impact of Debit Valuation Adjustment (DVA) on assets, extending existing models to include asset DVA, and demonstrates its significance through calibration to bank data during the financial crisis.

Contribution

It extends prior DVA models to assets, providing a hedging strategy and applying it to real bank data to assess effects on reported profits.

Findings

Including asset DVA significantly alters profit calculations.

Hedging DVA on assets is crucial for accurate financial reporting.

Model calibration shows notable impact during financial crisis periods.

Abstract

The effect of self-default on the valuation of liabilities and derivatives (DVA) has been widely discussed but the effect on assets has not received similar attention. Any asset whose value depends on the status, or existence, of the firm will have a DVA. We extend (Burgard and Kjaer 2011) to provide a hedging strategy for such assets and provide an in-depth example from the balance sheet (Goodwill). We calibrate our model to seven US banks over the crisis period of mid-2007 to 2011. This suggests that their reported profits would have changed significantly if DVA on assets, as well as liabilities, was included - unless the DVA was hedged.