I really need some help on this one - we have a USDJPY FVA on our portfolio (3y5y), however our PM states that it is being massively undervalued by the 3rd party admins and by the internal system - he states that the arithmetic fwd fwd vol is undervaluing the trade because, in this case, the USDJPY and the interest rates used to determine the forwards (i.e. USD Rates given JGBs are pegged) are highly correlated. Because of this Correlation the USDJPY Spots are more volatile than the forwards so as US Rates go up, USDJPY goes up and the swap gets wider so the FWD hasnt moved as much. He then says that because of this USDJPY FVAs trade at a premium to the fwd-fwd levels and that Id rather own 5 discrete 1y fvas then own a 5y vol from spot.
So my question is - How does high correlation make USDJPY Spots more volatile than forwards and how does this lead to USDJPY FVAs trading at a premium to the arithmetic fwd fwd? Can someone more clued up than me help? Still pretty new to the FX desk.
Thanks so much it will literally help so much if one of you kind people can advise