Credit Valuation Adjustment (CVA)

The market value of counterparty default risk — the expected cost of the counterparty failing to pay on a derivative.

CVA is a bilateral adjustment subtracted from the risk-free derivative value to account for the possibility that the counterparty defaults during the contract's life. CVA = LGD × ∫EE(t) × λ(t) × DF(t) dt, where EE(t) is Expected Exposure at time t, λ(t) is the counterparty's hazard rate, LGD is Loss Given Default (1 − Recovery Rate), and DF(t) is the risk-free discount factor. For an IRS, EE(t) follows the swap's MTM distribution over time. CVA became central to bank capital requirements (Basel III, FRTB) after the 2008 crisis revealed massive unhedged counterparty credit losses.

Formula

\text{CVA} \approx \text{LGD} \times \sum_i EE(t_i) \cdot PD(t_i) \cdot DF(t_i)

Related Terms

Debt Valuation Adjustment (DVA)

The benefit to a party from its own potential default — the mirror image of CVA applied to your own credit risk.

Bilateral CVA (BCVA)

Net XVA combining your counterparty's default risk (CVA) and your own default risk (DVA).

Interest Rate Swap (IRS)

An agreement to exchange fixed-rate cash flows for floating-rate cash flows on a notional principal.

Discount Factor (DF)

The present value of $1 receivable at a future time T, derived from the zero curve: DF = e^(−rT).