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

13.5 Summary

In this chapter, we have discussed DVA, which is a controversial component of counterparty credit risk arising from an institution's ability to value the potential benefits they make from defaulting. We have given the theoretical background to DVA and shown how it can be computed in a very similar manner to CVA. The strengths and weaknesses of accounting for DVA on a balance sheet have been considered. Most importantly, we have described the ways in which an institution can attempt to monetise their DVA. These are far from perfect, although it could be argued that many attempts at monetising intrinsic value in financial markets, especially with respect to derivatives, are not perfect. Finally, we have described some of the complications arising from DVA use, such as the sensitivity to default correlation between the institution and their counterparty. We have shown that the correct evaluation of CVA and DVA with substitution closeout is complex but is reasonably well approximated by the bilateral formula (equation 13.1) but without inclusion of survival probabilities of the institution and counterparty.

DVA is likely to remain a hotly debated subject for some time. Those against DVA will argue that it is unnatural to book benefits from an increased likelihood of defaulting (just as life insurance doesn't make you rich), and may point to potentially unpleasant consequences (such as an institution profiting as their credit quality worsens). Proponents of DVA will argue ...