CVA Risk Management Post-Crisis

David Goulding


Since 2008 the importance of credit value adjustment (CVA) and the desks hedging it have grown within banks, and in this chapter we discuss the issues around pricing, hedging and managing CVA risk. At a high level the reason for the growth was twofold: first, the realisation during 2007–8 that relatively small CVA balances can explode on in essence the same positions; second, the new regulatory capital requirements around CVA.

The growth in CVA balances was caused by the unique feature of CVA in that it grows as credit spreads increase and as the underlying counterparty exposures increase. During the global financial crisis (ie, 2007–9) both spreads and exposures increased by multiples which overall led to an order of magnitude increase in CVA.

The new regulatory capital requirements arose from the realisation that some banks were incurring large losses due to poorly hedged CVA balances. This led to CVA and its associated hedges entering into the bank’s capital framework via the Basel III CVA value-at-risk (VaR) and regulatory stress-testing regimes. With these changes, CVA is often the largest single capital constraint on trading activity.

In this chapter we discuss the

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