Credit Value Adjustment

Topics: Risk, Derivatives, Risk management / Pages: 26 (4666 words) / Published: Aug 21st, 2014
CREDIT VALUE ADJUSTMENT
AND THE CHANGING ENVIRONMENT FOR PRICING AND MANAGING COUNTERPARTY RISK

CREDIT VALUE ADJUSTMENT
AND THE CHANGING ENVIRONMENT FOR PRICING AND MANAGING COUNTERPARTY RISK

Executive Summary
The market volatility experienced during the financial crisis has driven many firms to review their methods of accounting for counterparty credit risk. The traditional approach of controlling counterparty credit risk has been to set limits against future exposures and verify potential trades against these limits. Credit Value Adjustment (CVA) offers an opportunity for banks to move beyond the control mindset of limits by dynamically pricing counterparty credit risk directly into new trades. Many banks already measure CVA in their accounting statements, but the financial crisis has led pioneering banks to invest in systems that more accurately assess CVA, and integrate CVA into pre-deal pricing and structuring.
Their expected return on investment is the ability to support future growth by freeing up more capital and minimizing earnings volatility.
As part of ongoing research, Algorithmics has conducted in-depth interviews with risk professionals to gain insight on the approach their firm is taking on emerging opportunities for CVA. These discussions provide us with an understanding on how CVA is currently being measured, where CVA fits into their systems, and how CVA practices are expected to evolve.

Key Findings
• Most institutions are pricing CVA into trades at deal time. Institutions are investing heavily to enhance their counterparty risk system capabilities to calculate real-time incremental CVAs so that risk reducing trades can be priced more aggressively than risk increasing trades. Much of the push for incremental CVA comes from the front office, with traders concerned that the inability to properly assess CVA on a real-time basis is resulting in lost business due to the use of simple, and therefore necessarily

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