What is credit valuation adjustment?

Credit valuation adjustment (CVA) is the market value of counterparty credit risk, which occurs when a party in an agreement fails to meet its financial obligations. It’s used to measure the difference between the true portfolio value (taking into account the possibility of counterparty default, and the risk-free portfolio value.

Where have you heard about credit valuation adjustments?

It’s likely you’ll have heard of credit valuation adjustments if you’re familiar with over-the-counter (OTC) derivatives, which are private trades conducted between two parties outside an exchange.

Debit valuation adjustment (DVA) is the opposite of credit valuation adjustment and is the loss incurred by your counterparty should you default on an agreement.

What you need to know about credit valuation adjustments.

A credit valuation adjustment takes into account market risk factors and counterparty credit spreads which is the difference in profit between two bonds of similar maturity but different credit quality.

Credit worthiness is a valuation that determines the possibility of default and is a factor that can impact credit valuation adjustment. If the agreement has a long time to maturity, this can also negatively impact the credit valuation adjustment as there is a greater likelihood of default over time.