Things not clear about CVA

[afterworkguinness]

Hi @David Harper CFA FRM CIPM ,

If CVA represents the risk to both parties, how come it is calculated (in Gregory 12.2) using the exposure of the firm to its counterparty (B) and counterparty B's PD ? Why don't we somehow incorporate both PDs ?

I'm having a lot of trouble with the Gregory readings, I find they don't fully explain things. Hope I'm not alone.

 

[QuantMan2318]

I think I have a hunch, as no-one has answered, I am hazarding the following,

We ignore the probability that the firm itself can default, that is we ignore the Debt Value Adjustment, so despite the fact that the credit derivatives have cash flows in either directions, we only take the Counterparty's PD
Gregory says that ignoring the firm's own PD is one of the fundamental assumptions to calculating the CVA. (at least initially)

Hope this is correct

 

[Nicole Seaman]

I think I have a hunch, as no-one has answered, I am hazarding the following,

We ignore the probability that the firm itself can default, that is we ignore the Debt Value Adjustment, so despite the fact that the credit derivatives have cash flows in either directions, we only take the Counterparty's PD
Gregory says that ignoring the firm's own PD is one of the fundamental assumptions to calculating the CVA. (at least initially)

Hope this is correct

Hello @QuantMan2318

I will let David explain if your answer is correct or not, but I am awarding you with one star in our weekly forum contest for trying to help another member

Nicole

 

[Matthew Graves]

As I understand it, @QuantMan2318 's answer is correct. CVA is a valuation adjustment you apply to attempt to counteract the credit risk of your counterparty. DVA is the opposite i.e. a valuation adjustment applied to counteract your credit risk to your counterparty. In my experience, both are often applied.

 

[afterworkguinness]

@QuantMan2318 and @Matthew Graves , thanks for your help.