Counterparty Credit Risk and Credit Value Adjustment: A Continuing Challenge for Global Financial Markets, 2nd Edition

12.6 Summary

This chapter has been concerned with the pricing of counterparty risk via CVA. The computation of CVA has been detailed from the commonly made simplification of no wrong-way risk, which assumes that the credit exposure, default of the counterparty and recovery rate are not related. We have shown the relevant formulas for computing CVA in their simplest possible forms (all the details can be found in the appendices to this chapter, found on cvacentral.com). The concepts of incremental and marginal CVA have been introduced and illustrated in order to provide a means to price new or existing trades. We have discussed the specifics of calculating CVA, including collateral and netting, and covered some more complex aspects such as numerical implementation, exotic products and path dependency.

In the next chapter, we continue to discuss pricing counterparty risk, incorporating the default probability of an institution into the analysis (DVA). Over the last few years, this has been an important and controversial aspect of pricing counterparty risk. We will also consider some other important effects related to DVA.

Notes

1. Also sometimes referred to as counterparty value adjustment.

2. And, also, the recovery value.

3. It is also smaller due to the lack of a principal payment but this is a different point.

4. Indeed, the trader need know nothing whatsoever about CVA although, since CVA is a charge to their PnL, it is likely they will want at least a basic understanding of ...