Closing out DVA?
by Jon Gregory of Solum Financial Partners, and
July 18, 2012
Abstract: Counterparty risk valuation often includes the debt value adjustment (DVA) component linked to an institution's own default which is viewed by some as contentious. However, there are several possible practical ways that an institution can monetise their DVA. One is, perversely, when their counterparty defaults where standard documentation seems to dictate that DVA may be considered in any amounts owed to or claims against the defaulted counterparty ("risky closeout"). However, doing this adds complexity to the already difficult problem of counterparty risk valuation. In this article, we analyse the complex interaction between CVA, DVA and closeout assumptions and the general accurate calculation of CVA and DVA with risky closeout assumptions. We also consider if there is a simpler formula that can be used as a good approximation for risky closeout, without the need for adding complexity to CVA quantification.
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