The CVA Diary - Some Definitions

Some of the blog readers may have recognised what the pictures I posted on last physic's friday have been about. I am currently working on the implementation of a xVA simulation, where xVA stands for all kind of VAs (CVA - Credit Value Adjustment, DVA - Debt Value Adjustment, BCVA - Bilateral Credit Value Adjustment and FVA - Funding Value Adjustment).
But what are these VAs about: Counterparty risk represents a combination of market risk, which defines the exposure, and credit risk, which defines the counterparty credit quality. Part of the global regulation arising in the aftermath of the global financial crisis (e.g., Basel III) seems to view CVA as necessarily being a marked-to-market trading book component, alongside the OTC derivatives position from which it is derived. The risky price of a derivative can be expressed as the risk-free price (the price assuming no counterparty risk) minus a component to correct for the counterparty risk. The later component is often called CVA.

In next weeks physic's friday I will start with the description of the exposure engine - the heart of each xVA simulation.