Chia Chiang Tan: CVA, FVA and DVA – where they matter

(The Thalesians – 26/02/14)

On Wednesday, I went to my first Thalesians meetup in quite a while. In terms of outside work learning, I have recently focussed a lot on the technology side and let finance be finance. I keenly felt this, when I went to this meetup. For one thing, they had moved venues (at least the Imperial math-finance seminar is still in room 139 in the Huxley building. I don’t know what I would do if they ever moved!). More importantly, though I felt that I was familiar with the basics of the topics discussed this evening (e.g. yield curve reforecasting and discounting, spread between Libor and more collateralised curves and how this affects discounting) as well as the basic interest rate models (Hull-white, Libor market model etc.), I clearly did not recognise some of the more recent models mentioned in the talk. Time to swot up on these – me thinks!

Interestingly, though, Chia talked about where it is important to know these new models (i.e. what circumstances they really need to be used) and where they may not make a material difference: The talk was a very interesting meta-discussion about model accuracy and uncertainty.

His underlying argument is that model simplicity helps us by enabling our intuition. Using a more complex model, we may not be able to verify more than “all the inputs look about right” and “using those inputs, yes we do get a number back”.

The physics metaphor here is the fairly obvious one between Newtonian physics and Relativistic physics (not that I know anything about it :o) ). However, there are circumstances when the simpler one really works rather well (“normal life”) and circumstances where you really need to use the other one (“travelling close the speed of light”).

Chai explored this topic in detail giving a variety of examples of when a more integrated approach is necessary (e.g. “long maturity”, “transformational trades”, “wide choice of collateral – including currency” etc.) and scenarios where it is not (“short maturities”, “exchange trading”, “CSA supported trades”).

In short – very enjoyable!

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