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FRM Part II · FRM Exam Part II · Credit Value Adjustment

A risk manager argues against allowing DVA to count towards regulatory capital or to be used in pricing new trades. Which rationale is most consistent with the standard concerns about DVA?

The main concern is that DVA is hard to realize for a going concern, since gains arise only on the bank's own default or debt repurchase, and it perversely produces profits when the bank's own credit quality deteriorates.

  1. ADVA gains cannot be realized by a going concern without defaulting or hedging through its own debt, and it creates perverse gains when credit quality deterioratesCorrect
  2. BDVA always exceeds CVA, so it overstates profit
  3. CDVA depends on the counterparty's recovery rate only
  4. DDVA is incompatible with any use of risk-neutral default probabilities

Explanation

DVA is hard to monetize because the bank would have to default or buy back its own debt to realize it, and it generates profit as the bank's credit worsens. It does not systematically exceed CVA, and it is computed with risk-neutral own default probabilities, so the other options are false.

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