18.2 The Role of a CVA Desk
Not all traders and businesses can become experts in counterparty risk and CVA.2 CVA can be a significant and exotic component of a valuation, as illustrated in Figure 18.1. Here, without CVA the PnL is a simple linear function of the market move, whereas CVA introduces a more complex non-linear behaviour. Due to the potentially complex nature of CVA, there is a need to centralise its management and decentralise the associated PnL from individual trading desks.
To achieve this, there are two primary needs (Figure 18.2):
- Transfer pricing. Counterparty risk arises very heterogeneously. Short-dated trades, high-quality and collateralised counterparties all lead to relatively small CVAs. On the other hand, long-dated trades, weaker credit quality, uncollateralised counterparties and wrong-way risk give rise to significant CVAs. It is important to charge the correct CVA to each trade, preferably at inception, accounting for important aspects such as up-front payments, yield curve shapes and risk mitigants such as netting and collateral. This correctly accounts for the expected cost of the counterparty risk and incentivises ...
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