What are CVA and DVA adjustments to derivative fair value?

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AcadiFi · Accepted Answer

**CVA (Credit Valuation Adjustment)** is the market value of counterparty credit risk in an uncollateralized derivative. It reduces the fair value of a derivative asset to reflect the probability that the counterparty defaults before paying you. **DVA (Debit Valuation Adjustment)** is the mirror image — the market value of your own credit risk on a derivative liability. It reduces the fair value of your liability because there's a probability YOU default before paying the counterparty. Formula concept: CVA ≈ Σ [EE(t) × PD(t) × LGD], where EE = expected exposure, PD = counterparty probability of default, LGD = loss given default. Worked example: Hestia Treasury Group holds an uncollateralized 5-year interest rate swap with Farragut Midstream Inc. with risk-free fair value of $4.2M (in Hestia's favor). Farragut's CDS spread is 285bps, implying cumulative 5-year PD of ~13.8%. Using expected positive exposure profile, CVA = $480K. Fair value reported = $4.2M − $480K CVA = $3.72M. Symmetrically, Hestia has another derivative with Farragut that is a $1.9M liability. Hestia's own CDS spread is 140bps. DVA on this liability = $110K. Hestia reports the liability at $1.9M − $110K = $1.79M. ```mermaid graph TD A[Risk-free
derivative value] --> B[Subtract CVA
counterparty risk] B --> C[Add back DVA
own credit risk] C --> D[Reported
fair value] ``` Controversial aspect: DVA creates the counterintuitive outcome that when a bank's own credit deteriorates, it books a DVA GAIN. Dodd-Frank now excludes DVA from regulatory capital to prevent this distortion from boosting capital ratios during stress.

What are CVA and DVA adjustments to derivative fair value?

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