Using credit valuation adjustment to set limits
In their previous article, Carlos Blanco and Michael Pierce introduced the concept of credit valuation adjustment (CVA). In this next instalment, they explore CVA allocation methods and discuss alternative structures using CVA to set limits, credit charges and perform risk-adjusted pricing for new transactions
When two entities enter into a series of transactions, they also exchange an implicit option to default. Credit valuation adjustment (CVA) is the price or cost of credit risk for a deal or portfolio with a given counterparty.
CVA can be calculated at the individual transaction level or for each counterparty portfolio. The overall CVA for the exposures with a given counterparty is not simply the sum of the CVAs for individual deals, because of the need to take into account credit risk mitigation
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