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Abstract
There was a time when banks could borrow and lend at the risk-free rate and when a derivatives desk's cost of funding was not an existential issue. Those happy, carefree days ended with the financial crisis, forcing banks to fund their trades at a spread above the risk-free rate and to focus more finely on pricing, separating out the credit, debit and funding valuation adjustments (CVA, DVA and FVA) that respectively reflect counterparty credit risk, risk of own default and cost of funding. While it is intuitively obvious where CVA and DVA come from, FVA, was controversial. Even its proponents were divided on how to explain it, and the mathematical foundation behind the adjustment was a mess -- that is, until two quants at Barclays got their teeth into it. Christoph Burgard, a managing director at Barclays and his then-colleague, Mats Kjaer, published their paper, Funding strategies, funding costs in Risk in December 2013.
