XVA at the Exercise Boundary

TL;DR

This paper investigates how XVA components influence the optimal exercise boundary of options, emphasizing the importance of including XVA in exercise decisions and demonstrating this impact through regression analysis on swaption examples.

Contribution

It introduces a method to evaluate XVA's effect on exercise decisions using regression techniques and assesses its significance through swaption case studies.

Findings

XVA significantly affects exercise boundary decisions.

Regression methods can quantify XVA impact.

Materiality varies across different swaption scenarios.

Abstract

XVA is a material component of a trade valuation and hence it must impact the decision to exercise options within a given netting set. This is true for both unsecured trades and secured / cleared trades where KVA and MVA play a material role even if CVA and FVA do not. However, this effect has frequently been ignored in XVA models and indeed in exercise decisions made by option owners. This paper describes how XVA impacts the exercise decision and how this can be readily evaluated using regression techniques (Longstaff and Schwartz 2001). The paper then assesses the materiality of the impact of XVA at the exercise boundary on swaption examples.