Credit Valuation Adjustment

[Yan He]

Does anyone has any information about this Credit Valuation Adjustment ?
It should be a new risk factor added in the calculation of credit charge for FI.


-Simplified Formulas
CVA=-Average Discounted Exposure * spread * Tenor
CVA=-Average Discounted Exposure * expected Loss

Do you hear any model that add this parameter? Thanks a lot.

-

 

[cmrm]

Check this paper
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2267508

 

[Ken Abbott]

The Canabarro and Duffie paper I posted in the Books section here under "Collection of important docs for risk management" has a nice description of CVA. There's also a lot of discussion of it in Basel III material, since B3 requires its inclusion in VaR.

 

[Sanket Patel]

The paper by Zhu and Pykhtin is another excellent introduction to CVA. Jon Gregory's book is also a good starting point. For a more technical resource centered around the challenges of actually implementing a CVA engine, check out Cesari et al.

 

[coolarbitrager]

What

Does anyone has any information about this Credit Valuation Adjustment ?
It should be a new risk factor added in the calculation of credit charge for FI.


-Simplified Formulas
CVA=-Average Discounted Exposure * spread * Tenor
CVA=-Average Discounted Exposure * expected Loss

Do you hear any model that add this parameter? Thanks a lot.

 

[coolarbitrager]

Does anyone has any information about this Credit Valuation Adjustment ?
It should be a new risk factor added in the calculation of credit charge for FI.


-Simplified Formulas
CVA=-Average Discounted Exposure * spread * Tenor
CVA=-Average Discounted Exposure * expected Loss

Do you hear any model that add this parameter? Thanks a lot.

-

What was that? Adjustment? What adjustment? Why the adjustment? Was something so very wrong with the current pricing theory that one has to make adjustment?! Ah...yes! Something was very wrong with the current financial maths and models, therefore we must, yes must, make all kinds of adjustments, be it Convexity adjustment, CVA, DVA, FVA, ETC., you name it, in order to make prices of derivatives appearing fair in the eyes of regulators!

Yes, adjustments we must make! Is this the best we can do? Adjustment is precisely how ignorant we are when dealing with risks, understanding risk.

Is this how we manage risks by making adjustments? And this is how we teach the next generations of practitioners to manage risks?

 

[euroazn]

What was that? Adjustment? What adjustment? Why the adjustment? Was something so very wrong with the current pricing theory that one has to make adjustment?! Ah...yes! Something was very wrong with the current financial maths and models, therefore we must, yes must, make all kinds of adjustments, be it Convexity adjustment, CVA, DVA, FVA, ETC., you name it, in order to make prices of derivatives appearing fair in the eyes of regulators!

Yes, adjustments we must make! Is this the best we can do? Adjustment is precisely how ignorant we are when dealing with risks, understanding risk.

Is this how we manage risks by making adjustments? And this is how we teach the next generations of practitioners to manage risks?

I throw a baseball up in the air at a 45 degree angle with a speed of 10 m/s a second. What time will it take to fall back to the ground?

If we use a model, we can say that the ball is affected by the force of gravity and experiences a downward acceleration of ~9.8 m/s^2. We get a pretty good answer.

But maybe we want a better answer! Then we can consider the effect of air resistance, and maybe use another model (for example, Stokes' law.) That's not perfect either though - what about the spin of the ball? And on and on and on.


Surely you're not suggesting that the original assumption of downward acceleration of 9.8 is that bad though.


Something that might come as a surprise to you is that economic/financial models are much the same.

 

[A modest quant]

We can't teach dogs quantum physics, as well we can't teach monkeys financial economics.

Yes, it surprises me that how one can view financial economics as physics, vice versa! Almost everything is predictable in the physical world. Almost everything is unpredictable in the financial market.

When you throw a baseball up at a certain angle, you're almost certain of where it will land and at which speed. When you buy a stock, you can almost only guess, and hope that you're right, of what's its worth some time in the future.

Just a thought, you might want to utilize String theory with 11 dimensions for predicting anything in the market. That would be a sight and a surprise to me. Surprise me!!!

 

[euroazn]

We can't teach dogs quantum physics, as well we can't teach monkeys financial economics.

Yes, it surprises me that how one can view financial economics as physics, vice versa! Almost everything is predictable in the physical world. Almost everything is unpredictable in the financial market.

When you throw a baseball up at a certain angle, you're almost certain of where it will land and at which speed. When you buy a stock, you can almost only guess, and hope that you're right, of what's its worth some time in the future.

Just a thought, you might want to utilize String theory with 11 dimensions for predicting anything in the market. That would be a sight and a surprise to me. Surprise me!!!

Black scholes, along with other reputable models, doesn't try to predict the future. It gives a consistent metric for what the price of something now should roughly be.

 

[euroazn]

Almost everything is predictable in the physical world.

Incidentally, this isn't true. Try forecasting the weather 15 days from now.

 

[A modest quant]

Incidentally, this isn't true. Try forecasting the weather 15 days from now.

Yes, weather is predictable in a near future! This is why people don't trade options on weather, 15 days weather. People buy insurance against disasters. And insurers (actuaries) use more of statistic discipline for calculation, not physics. Stock prices are not predictable, and financial derivatives are as insurances which should, rather must, not be calculated by using physical laws.