CVA's cousin: Dealers try to value early termination clauses
Much of the talk about counterparty risk has concentrated on tweaks due to default expectations – credit and debit value adjustments – but there are other legal loopholes that allow counterparties to terminate trades. One in particular – using credit downgrades as a trigger – is now animating modellers, and is potentially the most complex adjustment yet. By Laurie Carver
Since the collapse of Lehman Brothers three years ago this month, banks, regulators and accountants have been struggling to ensure default risk is priced, reported and capitalised accurately through the use of credit value adjustment (CVA) and its more controversial twin, debit value adjustment (DVA).
Now, the implications of another type of counterparty risk are beginning to occupy quants and dealers. It’s a new creature that doesn’t even have a proper name yet. All anyone knows is that it
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