Model foundations of the Basel III standardised CVA charge

The credit value adjustment (CVA) capital charge in Basel III comes in two flavours: advanced (simulations) and standardised (formula). In this article, Michael Pykhtin shows that the standardised CVA charge formula can be obtained by adding several conservative adjustments to an analytical approximation of CVA value-at-risk under a single-factor lognormal model of credit spreads. He uses sample portfolios to quantify overstatement of CVA capital by the Basel III formula over the underlying model and discusses the hedging implications

One of the primary focus points of Basel III rules on minimum capital requirements issued by the Basel Committee on Banking Supervision (2010) has been counterparty credit risk (CCR).1 Among other things, Basel III has introduced the concept of credit value adjustment (CVA) into calculations of the CCR capital. In particular, in addition to the default capital, banks are required to calculate a CVA capital charge. This accounts for losses resulting from an increase of CVA due to deterioration of