Cutting Edge introduction: pricing the CVA doom loop
The credit valuation adjustment charge in Basel III allows capital relief for credit default swap (CDS) hedges. But once a product has a new use, it creates new demand – and prices must change. That has unsettling implications for the CDS market. Laurie Carver introduces this month’s technical articles
In its half-year results, Deutsche Bank revealed it had lost €94 million as the result of a capital relief programme. The loss was from credit default swap (CDS) positions that can be used to mitigate Basel III’s charge for credit valuation adjustment (CVA) volatility – which they did, and then some. The bank’s capital requirement halved from €28 billion to €14 billion.
Whether this was worth it is a matter of opinion, but it illustrates the different uses to which derivatives can be put in the
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