Chapter 15

Counterparty Valuation Adjustments

Harvey J. Stein

Bloomberg LP

Kin Pong Lee

Bloomberg LP

The financial crisis that began in 2007 has highlighted the importance of assessing counterparty credit risk. Regulations, accounting practices, and investment practices are all being reshaped to better manage counterparty risk.

Here we review the need for counterparty credit risk analysis, focusing on accurate computation of the counterparty valuation adjustment (CVA). We

  • Provide a general framework for computing CVA
  • Relate the CVA to the value of a portfolio of options
  • Compare the CVA of bonds to swaps
  • Analyze other approaches to CVA management (such as discount shifts, current exposure, and bilateral CVA)
  • Discuss hedging methodologies

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