It constitutes part of x-value adjustments (XVA). By definition, it is the valuation of counterparty credit risk (CCR), for pricing of a derivative instrument, which takes into consideration the potential default of the counterparty to the derivative transaction, calculated over the remaining lifespan of the instrument. It is trade, portfolio, and counterparty-specific adjustment, as it represents the features and profile of every trade. In simple words, credit valuation adjustment is the market value of counterparty credit risk.
In calculation, the credit valuation adjustment includes the following components:
- probability of default (of the counterparty) (PD).
- recovery rate (RR) or loss given default (LGD).
- exposure at default (EAD) value (estimated over the lifespan of the trade/ portfolio, then discounted and aggregated).
