81,681
edits
Credit value adjustment: Difference between revisions
Jump to navigation
Jump to search
no edit summary
Amwelladmin (talk | contribs) No edit summary |
Amwelladmin (talk | contribs) No edit summary |
||
| (One intermediate revision by the same user not shown) | |||
| Line 1: | Line 1: | ||
{{g}}''Warning: ramblings of an untutored maniac here.'' | {{g}}''Warning: ramblings of an untutored maniac here.'' | ||
===[[Credit value adjustment]]s=== | ===[[Credit value adjustment]]s=== | ||
A [[credit value adjustment]] — to its friends '''[[CVA]]''' — is a calculation made by financial reporting types to [[financial instrument]]s one holds to account for changes in the [[creditworthiness]] of the [[issuer]] of those instruments since their issue. For a liquid instrument the [[CVA]] ought really to be baked into the [[mark-to-market]] value of the instrument. For a [[Variation margin|collateralised]] one, it ought to be small. As far as this [[Jolly Contrarian|bear of little brain]] can see, it ought really to be the difference between the [[present value]] of the notional [[cashflows]] due on that instrument (that is, ignoring the risk of [[default]]) and the price at which that instrument is trading. | A [[credit value adjustment]] — to its friends '''[[CVA]]''' — is a calculation made by financial reporting types to [[financial instrument]]s one holds to account for changes in the [[creditworthiness]] of the [[issuer]] of those instruments since their issue. For a liquid instrument, the [[CVA]] ought really to be baked into the [[mark-to-market]] value of the instrument. For a [[Variation margin|collateralised]] one, it ought to be small. As far as this [[Jolly Contrarian|bear of little brain]] can see, it ought really to be the difference between the [[present value]] of the notional [[cashflows]] due on that instrument (that is, ignoring the risk of [[default]]) and the price at which that instrument is trading. | ||
===[[Debt value adjustment]]s — | ===[[Debt value adjustment]]s — {{t|snake oil}} alert=== | ||
:''“[[DVA]] has caused a lot of confusion because banks are allowed to record gains as their credit quality deteriorates. While there are pros and cons to including [[DVA]] in earnings, most people see it as accounting gimmickry that doesn’t reflect any true economic value.” | :''“[[DVA]] has caused a lot of confusion because banks are allowed to record gains as their credit quality deteriorates. While there are pros and cons to including [[DVA]] in earnings, most people see it as accounting gimmickry that doesn’t reflect any true economic value.” | ||
::—David Kelly, Quantifi, 2009, quoted in [https://www.euromoney.com/article/b12kjc667rjrsq/the-truth-behind-cvas-dvas-and-banking-results?copyrightInfo=true Euromoney] | ::—David Kelly, Quantifi, 2009, quoted in [https://www.euromoney.com/article/b12kjc667rjrsq/the-truth-behind-cvas-dvas-and-banking-results?copyrightInfo=true Euromoney] | ||
The imposition of [[CVA]] adjustments during the [[global financial crisis]] — it was a [[Basel]] requirement — where counterparties had, effectively, to discount the value of their claims under [[derivative]] contracts due to deterioration in their counterparties’ [[creditworthiness]], led resourceful types to wonder whether they shouldn’t also be able to discount the book value of their ''[[liability|liabilities]]'' under the same {{t|contract}}s due to a deterioration in their ''own'' [[creditworthiness]] | The imposition of [[CVA]] adjustments during the [[global financial crisis]] — it was a [[Basel]] requirement — where counterparties had, effectively, to discount the value of their claims under [[derivative]] contracts due to deterioration in their counterparties’ [[creditworthiness]], led resourceful types to wonder whether they shouldn’t also be able to discount the book value of their ''[[liability|liabilities]]'' under the same {{t|contract}}s due to a deterioration in their ''own'' [[creditworthiness]]. | ||
There is a neat logic to this — if I consider [[out-of-the-money]] exposures to be my term [[indebtedness]], then if my prospects have worsened, I would be able to buy this back at a discount to its face value for exactly the same reason, so why shouldn’t I mark it down? | There is a neat logic to this — if I consider [[out-of-the-money]] exposures to be my term [[indebtedness]], then if my prospects have worsened, I would be able to buy this back at a discount to its face value for exactly the same reason, so why shouldn’t I mark it down? | ||
So the [[investment bank]]s did, and in size. They called these “[[debt value adjustment]]s”, and while it was a thing, it didn’t fare so well and these days there aren’t as many Investopedia articles about it. But, around 2011, it was the talk of the smoky salons where credit traders would gather to complain to each other about the prevailing squeeze on their credit. Strangely, as this alleviated, they grew less enthusiastic about having to pay to hedge away the cost of their own improving fortunes with [[credit derivatives]] as, oddly it began to seem a bit silly. | |||
“But,” I hear you cry, “I could buy that [[indebtedness]] back in the market at | So you would not be alone if you felt something tugging at your gut saying this seems a bit [[snake oil]]-y. Because it is. If you think your ''own'' credit deterioration is an excuse to book a ''profit'', you should get your coat. Just because, as you lurch towards [[insolvency]], the value ''to your creditors'' of your [[liabilities]] tends to zero, it doesn’t mean their cost ''to you'' tends to zero. You are still fully liable for that [[indebtedness]], come what may. That you should have collapsed into ignominious torpor of [[bankruptcy]] before being able to honour it does not mean your obligation doesn’t exist, and it certainly shouldn’t go towards your [[pnl]]. | ||
“But,” I hear you cry, “I could buy that [[indebtedness]] back in the market at that [[discount|discounted]] va —” | |||
WITH WHAT, DEAR LIZA? The theory is ''your business is swan-diving into the side of a hill''. If you had free [[cash]] available to buy out all your debts, ''said hill would not be filling up your entire field of vision''. You don’t have any goddamn money to buy your debts back. That is your ''exact'' problem. | WITH WHAT, DEAR LIZA? The theory is ''your business is swan-diving into the side of a hill''. If you had free [[cash]] available to buy out all your debts, ''said hill would not be filling up your entire field of vision''. You don’t have any goddamn money to buy your debts back. That is your ''exact'' problem. | ||