Closing out DVA

The choice of a close-out convention applicable on the default of a derivatives counterparty can have a significant effect on the credit and debit valuation adjustments, as can the order of defaults. Jon Gregory and Ilya German examine this phenomenon in detail

Financial institutions often consider their own default in the valuation of liabilities, including a so-called debit valuation adjustment (DVA) opposite the credit valuation adjustment (CVA) accounting for the counterparty’s default. DVA is a double-edged sword. On the one hand, it creates a symmetric world where counterparties can readily agree on pricing. On the other hand, its nature creates some potentially unpleasant effects, such as institutions booking profits arising from their own