FVA

Funding Valuation Adjustment, or FVA, is a concept in derivatives pricing that reflects the cost of funding a position over its life. It captures the funding costs associated with borrowing or posting collateral, as well as the opportunity costs of tying up capital. FVA is one of the adjustments in the family known as XVA, complementing other measurements such as CVA for credit risk and DVA for own credit risk.

Intuitively, FVA represents how the price of a derivative would change if a bank had to fund its exposure at its own funding rates and collateral terms rather than at a risk-free rate. It is not solely a market observable; it depends on the institution’s funding curve, collateral agreements, and hedging strategy. Because of this, FVA values can differ across institutions and models.

Calculation can be framed as the present value of expected future funding costs, obtained by integrating funding spreads over the uncollateralized cash flows, adjusted for discounting and margining. Practical models use funding rate curves, collateralization status, netting sets, and assumptions about hedging. The result can be a separate adjustment added to the risk-free valuation or embedded in the pricing model.

There is debate about FVA, with critics arguing it can introduce nonlinearity or potential double counting and complicate accounting. Proponents say it aligns prices with real funding costs and risk management realities, reflecting economic considerations behind derivative trades.

In practice, FVA is used by banks and financial institutions in pricing and risk assessment of derivative portfolios, and it interacts with other XVAs and regulatory capital considerations.