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

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13.2 The DVA Controversy

13.2.1 Liability Measurement and Accounting Standards

The issue of DVA in counterparty risk is a small component of a broader issue which is the general incorporation of credit risk in liability measurement. The question is: should an institution measure its liabilities including the possibility of their own financial failure? This has been a very significant question for banks in the last few years since their “own credit risk” (via credit spreads) has seen unprecedented volatility.

Accountancy standards have generally evolved to a point where “own credit risk” can be incorporated in the valuation of liabilities. For example, relevant for the US, the FASB7 issued in 2006 SFAS 157, relating to fair value measurements, which became effective in 2007. This permits an institution's own credit quality to be included in the valuation of their liabilities, stating “The most relevant measure of a liability always reflects the credit standing of the entity obliged to pay”. Amendments to IAS 39 by the International Accounting Standards Board (IASB) in 2005, relevant for the European Union, also concluded that the fair value of a liability should include the credit risk associated with that liability. This position is reinforced with the introduction of IFRS 13, which unites international and US accounting treatments, at the beginning of 2013.

Why do accounting rules view an institution's own credit risk as being an important component of fair value measurement? ...

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