Abstract
When considering counterparty credit risk, it has become increasingly common in recent years for institutions to consider bilateral CVA which includes debt value adjustment (DVA) linked to their own default probability. However, the use of DVA is contentious as it is not obvious that an institution can monetise this “profit” prior to actually defaulting. Furthermore, the use of DVA also seems to require an understanding of the dependence between the default probability of the institution and their counterparty and introduces ambiguity over the correct choice of “closeout” assumptions. In this article, we analyse the complex interaction between CVA, DVA and closeout assumptions and consider if the relatively simple formulas used for bilateral CVA in the industry are reasonable.
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