The impossibility of DVA replication

Some have argued that the debit valuation adjustment – which measures the benefit to a bank from its own potential for default – is monetisable. They claim replication strategies involving the dealer buying its own bonds, or writing protection on its peers, can achieve this. Not so, says Antonio Castagna, who argues that these strategies ignore subtle effects on the firm’s balance sheet

The debit valuation adjustment (DVA) that mark-to-market accounting rules insist should be included in derivatives’ prices in order to capture a bank’s own default risk is controversial because the dealer records paper profits – that could even be distributed as staff remuneration – when its creditworthiness deteriorates. Some argue that the DVA is not merely an accounting adjustment, but instead