Being able to price the stand-alone CVA on a given transaction is useful, but the need to account for risk mitigation such as netting and collateral is critical for any practical use of CVA.
When there is a netting agreement then the impact is likely to reduce the CVA and cannot increase it (this arises from the properties of netting described in Section 8.4). We therefore know that for a set of netted trades (NS):
where is the total CVA of all trades under the netting agreement and is the stand-alone CVA for trade i. The above reduction can be substantial and the question then becomes how to allocate the netting benefits to each individual transaction. The most obvious way to do this is to use the concept of incremental CVA, analogous to incremental EE discussed in Section 18.104.22.168 Here the CVA of a transaction i is calculated based on the incremental effect this trade has on the netting set:
The above formula ensures that the CVA of a given trade is given by its contribution to the overall CVA at the ...