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Credit Valuation Adjustment (CVA)

Credit Valuation Adjustment (CVA) is a risk management technique used by financial institutions to account for the risk that a counterparty might default on its obligations in an over-the-counter (OTC) derivative transaction. CVA adjusts the market value of the derivative by factoring in the credit risk of the counterparty. This adjustment is typically applied to protect institutions from potential losses arising from default or credit deterioration.

Example

A bank trading interest rate swaps applies a CVA to the value of the contract to reflect the increased risk of the counterparty defaulting on its payments.

Key points

• CVA is an adjustment to the value of a derivative to account for counterparty credit risk.

• It helps financial institutions manage the risk of default in OTC derivative transactions.

• CVA ensures that the potential cost of counterparty risk is reflected in the pricing of the contract.

Quick Answers to Curious Questions

CVA adjusts the value of a derivative to account for the risk that the counterparty may default, protecting institutions from potential credit-related losses.

CVA increases the cost of the derivative by reflecting the credit risk associated with the counterparty, ensuring that the risk is priced into the transaction.

CVA is commonly applied to over-the-counter (OTC) derivatives such as swaps and forward contracts, where counterparty credit risk is a concern.