DVA in the Structured Notes Issuance Portfolio

Abstract: This thesis focus on the issuer credit risk in financial derivatives held by a structured notes desk. Post-crisis derivative valuation includes valuation adjustments for credit, collateral and funding risk, commonly referred to as xVA. Debt Value Adjustment (DVA) is the integral cost of the issuer's own credit risk in a derivative as it is held on the issuer's balance sheet. In this thesis the DVA of the structured notes desk is defined and the factors that affect it are identified. Systematic strategies for minimizing the variance of the DVA under the constraints the structured note desk faces in reality are considered and tested on a sample portfolio. The results from the hedging strategies show that the variance of the DVA can be reduced. The most successful hedge utilizes index futures and attempts to capture regional systematic market risk. However, the effectiveness of the hedges are modest, still the findings should be guiding when setting up a hedging strategy in practice.