Section III: Credit Value Adjustment
In this section, we discuss the pricing of counterparty credit risk via credit value adjustment (CVA). CVA is becoming an increasingly important concept for banks and other financial institutions, driven by accounting standards, regulation and best practice. In its most simple form, CVA quantification is relatively simple, respecting just a combination of exposure and default probability as already discussed in Chapters 9 and 10. Nevertheless, being able to compute CVA in an efficient, accurate and timely fashion represents a number of challenges. Chapter 12 will cover the basics of CVA and methods for quantifying CVA. Of particular importance is that CVA is increasingly commonly calculated with reference to market parameters (risk-neutral) rather than real-world (e.g., historical) ones. This means that daily, and even intradaily, CVA calculations are increasingly becoming the norm. The pricing of new trades is often done with real-time incremental CVA calculations, which are challenging to make accurately. The market standard calculations and methodology for CVA will be described.
Another component of counterparty credit risk is debt value adjustment (DVA), which is the subject of Chapter 13. DVA is a mirror image of CVA as it represents the pricing of counterparty risk considering an institution's own default. This might sound somewhat counterintuitive but is a common practice, which is supported by accountancy standards. DVA has some theoretically ...
