Credit Valuation Adjustment Compression by Genetic Optimization

Abstract

Since the 2008–2009 financial crisis, banks have introduced a family of X-valuation adjustments (XVAs) to quantify the cost of counterparty risk and of its capital and funding implications. XVAs represent a switch of paradigm in derivative management, from hedging to balance sheet optimization. They reflect market inefficiencies that should be compressed as much as possible. In this work, we present a genetic algorithm applied to the compression of credit valuation adjustment (CVA), the expected cost of client defaults to a bank. The design of the algorithm is fine-tuned to the hybrid structure, both discrete and continuous parameter, of the corresponding high-dimensional and nonconvex optimization problem. To make intensive trade incremental XVA computations practical in real-time as required for XVA compression purposes, we propose an approach that circumvents portfolio revaluation at the cost of disk memory, storing the portfolio exposure of the night so that the exposure of the portfolio augmented by a new deal can be obtained at the cost of computing the exposure of the new deal only. This is illustrated by a CVA compression case study on real swap portfolios.

Credit Valuation Adjustment in Financial Networks

“…The use of genetic algorithms for optimizing the portfolio CVA is explored in Chataigner and Crépey (2019). Crépey (2015) develop a way to calculate CVA under funding constraints using reduced-form backward stochastic differential equations.…”

“…Since 2010, CVA risk has become a core component of counterparty credit risk in the current international banking regulation framework of Basel III (BCBS, 2019). The importance of CVA has been increasingly recognised by scholars in a body of academic works investigating key aspects, including the pricing of portfolios of contracts (Brigo et al, 2014;Bo and Capponi, 2014), wrong-way-risk (Brigo and Vrins, 2016;Glasserman and Yang, 2018), and various important computational challenges (Chataigner and Crépey, 2019;Crépey, 2015).…”

Credit Valuation Adjustment Study

“…The use of generic algorithms for optimizing the portfolio CVA is explored in Chataigner and Cr´epey (2019). Cr´epey (2015) develops a way to calculate CVA under funding constraints using reduced-form backward stochastic differential equations.…”