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COUNTERPARTY CREDIT RISK: CVA, DVA, AND FVA

Counterparty credit risk (CCR) is the risk that a counterparty to a financial contract, such as a derivative, will default prior to the expiration of the contract and fail to make the required payments.

Before about 2006, financial institutions managed CCR mainly by measuring their potential future exposures—i.e., the likely maximum credit losses they might suffer—and then imposing limits on exposures to given counterparties and classes of counterparties. Firms also applied a range of collateralization and netting procedures to try to minimize their counterparty exposures.

Over time, some larger institutions began to calculate the expected losses associated with a counterparty exposure—effectively, ...

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