Abstract
In this paper, we propose a framework for credit and debit valuation adjustments (CVA and DVA, respectively) for options and option portfolios which is based on conic finance, that is, where the positions are valued at their bid or ask prices depending on whether they are assets or liabilities. This can be achieved by transforming the pricing measure via appropriate distortion functions, depending on (at least) one parameter. We apply our methodology, which is based on the Wang transform, to portfolios of European commodity futures options, and we show that both CVA and DVA are significantly impacted by bid-ask spreads, when compared to their traditional risk-neutral counterparts. In particular, we show that DVA decreases when computed under conic finance settings, which is in line with the regulatory efforts to rein in DVA gains for financial institutions resulting from their own credit quality deterioration. Finally, we investigate the robustness of our approach with respect to the calibrated parameters, and we show that the calibrated distortion parameter is an excellent explanatory variable for the observed bid-ask spreads.
Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
