Financial Engineering Practitioners Seminar: Agostino Capponi
Date: January 25, 2016 from 6:00 pm to 7:30 pm EST
Location: Davis Auditorium, CEPSR Building
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Title: Arbitrage-Free XVA

Abstract: The widening of the Libor-OIS spreads, peaking during the crisis, indicates that the assumption of a risk-free bank account for financing purposes is no longer sustainable. When managing a book of derivatives, a trader needs to take into account costs incurred for financing a number of operations. Those include maintaining the hedge of the position, posting collateral resources, and accounting for premature liquidation of the position at counterparty's default. The total cost of these operations is referred to as XVA, and is at the heart of globally consistent valuation procedures.

This talk develops a novel framework for computing the XVA of a European style claim. Based on no-arbitrage arguments, we derive stochastic equations associated with the replicating portfolios of long and short positions in the claim. This leads to the definition of buyer's and seller's XVA, which in turn identify a no-arbitrage interval. We express the XVA as a percentage of the publicly available price of the traded claim, and obtain tractable representations for it and for the corresponding hedging strategies. Our analysis suggests that both buyer's and seller's XVA become large when the position is highly collateralized or counterparty default risk is high.

Bio:  Agostino received his Master and Ph.D. Degree in Computer Science and Applied and Computational Mathematics from the California Institute of Technology, respectively in 2006 and 2009. His main research interests are in the area of systemic risk, counterparty risk, and the economics of clearinghouses. His research contributes to a better understanding of risk management practices, and to assess the impact of regulatory policies aimed at monitoring and stabilizing financial markets. His research has been published in top-tier journals, including Mathematical Finance, Operations Research, Management Science, and Review of Asset Pricing Studies. His work has also been published in leading practitioner journals and invited book chapters.

Agostino served as a member of the roundtable on central clearing interdependencies, a study group established by the Basel Committee on Banking Supervision (BCBS), the Committee on Payments and Market Infrastructures (CPMI), the Financial Stability Board (FSB), and the International Organization of Securities Commissions (IOSCO). He has been awarded a grant from the Institute for New Economic Thinking for his research on systemic risk. Agostino serves as the department editor for financial engineering at the IIE Transactions, and as an associate editor of Operations Research Letters.

Presentation Slides