Hans Edward Gennow: Valuation Adjustments of Illiquid Instruments

New regulation changes in the capital requirements directive have led to more stringent demands when calculating the capital base of a financial institute. Two important changes that have been made are concerning prudent valuations and valuation adjustments of financial instruments. The regulations are now formulated such that when estimating the valuation adjustments should several factors be taken into account. The individual factors might be difficult to estimate.

The purpose of this thesis is to suggest a method that can estimate the total valuation adjustment of a portfolio consisting of financial instruments without estimating each of the individual factors. This will be done by using the uncertainty in estimates of underlying market parameters, like volatilities, dividends and correlations. By taking an extreme conservative estimate of the market parameters is it believed that the total valuation adjustment can be estimated.