Counterparty Risk and CVA › Key Parameters
Michael BrenndoerferDecember 23, 20251 min read
Quantitative FinanceAll chapters Part 10 of 15Risk Management and Financial Risk Controls
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The key parameters for the CVA model are essential to understand because each one significantly influences the final CVA calculation:
- EE: Expected Exposure. The projected future value of the derivative (if positive) averaged across simulation paths. This captures the average amount at risk if default occurs.
- PD: Marginal Probability of Default. The probability of counterparty default occurring within a specific time interval. Higher default probabilities directly increase CVA.
- LGD: Loss Given Default. The portion of the exposure lost upon default, calculated as (1 - Recovery Rate). This represents what fraction of the exposure is lost rather than recovered through bankruptcy proceedings.
- D: Discount Factor. The value of a future dollar in today's terms, used to discount expected losses. Losses that might occur far in the future are less costly in present value terms.
- Spread: CDS Spread. The market-observed cost of credit protection, used to infer hazard rates. This is the primary market input for counterparty credit quality.