In this article we derive a capital valuation adjustment for derivatives transactions due to market incompleteness. This is motivated by the fact that a return on equity (RoE) in excess of the riskless rate is the result of undiversifiable portfolio risk.The valuation adjustment represents the...

In this article we introduce a new framework for counterparty risk model backtesting based on Bayesian methods. This provides a conceptually sound approach for analyzing model performance which is also straightforward to implement. We show that our methodology provides important advantages over...