Credit and Debit Value Adjustments: Customizing

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Credit and Debit Value Adjustments: Customizing

If you would like to calculate credit and debit value adjustments on the basis of expected exposures, you need to have specified the type of expected exposures in Customizing for Treasury and Risk Management under Basic Analyzer Settings Valuation Settings for the Calculation of Credit and Debit Value Adjustments Define Expected Exposure Types .
You use the expected exposure type to specify the method with which the expected exposures are calculated. You can choose from the following three options:
- Constant Exposure Approach
  The NPV of the financial transaction is calculated for the evaluation date, based on the assumption that the NPV remains constant until the end of the term. A plus sign denotes a constant expected positive exposure (EPE), and a minus sign denotes a constant expected negative exposure (ENE).
- Variable Exposure Approach
  For each EE date (maturity band date), the NPV is calculated for the evaluation date using the EE date as the horizon. Depending on whether the value determined has a plus or minus sign, it is either an ENE or an EPE.
  
  In the case of netting groups, the NPVs of the single transactions are first added together; subsequently, the decision regarding whether ENE or EPE applies for the EE date is made for that netting group.
- Manual Entry
  The system does not calculate the values of the expected exposures; instead, you enter the values manually using the function Enter Expected Exposures (transaction TPMEEM).
You need to have created a credit and debit value adjustment type in Customizing for Treasury and Risk Management under Basic Analyzer Settings Valuation Settings for the Calculation of Credit and Debit Value Adjustments Define Credit and Debit Value Adjustment Types .
In the credit and debit value adjustment type, you specify the credit and debit value adjustment calculation method. You have a choice between calculation method 1 Difference Method and calculation method 2 Based on Expected Exposures.

If you have opted for calculation method 2 Based on Expected Exposures, you then need to assign the type of expected exposures (EE type).

If you also want to perform calculations for netting groups, you need to select an allocation method. The allocation method specifies how the CVA/DVA values calculated for the netting group are distributed across the individual financial transactions of that netting group. You can use the following allocation methods:
- Gross Relative Fair Value Approach
  CVA and DVA are distributed across all transactions of the netting group in proportion to the NPV (fair value) of the transactions.
- Net Relative Fair Value Approach
  The system proportionally distributes CVA across the transactions with a positive NPV (fair value), and DVA across those with a negative NPV (fair value).
You need to have defined an evaluation type.
Depending on the CVA/DVA calculation method that you have chosen, specific settings need to be made in this evaluation type.
- CVA/DVA Calculation Method 1: Difference Method
  In this case, the system calculates the NPV using the yield curve stored in the evaluation type, and it calculates the risk-free NPV using the risk-free yield curve also stored in the evaluation type. If you have also made the settings for credit spreads, the system also takes credit spreads into account when calculating the NPV (in a composite yield curve). The CVA or DVA is the difference between the risk-free NPV and the NPV.
  
  You therefore need to make the settings for calculating the (risk-based) NPV in the evaluation type by assigning a yield curve and, if applicable, making the credit spread settings. You also need to assign a risk-free yield curve in the evaluation type.
  
  You need to specify the exchange rate type for currency translations.
- CVA/DVA Calculation Method 2: Based on Expected Exposures
  In this case, the system calculates the risk-free NPV using the risk-free yield curve stored in the evaluation type.
  
  The credit spread curves to be applied are determined using the derivation IDs assigned in the evaluation type.
  
  See also: Deriving Credit Spread Curves
  
  The credit spread curves determined in this way are required for the calculation of credit and debit value adjustments in order to obtain the product AWKT*LGD for the reference entity of the counterparty or of your own company:
  
  LGD*AWKT (t_i-1, t_i) = CS (t_i)*(t_i - t₀) - CS (t_i-1)*(t_i-1 - t₀)
  
  You need to specify the exchange rate type for currency translations.
If you need to calculate the credit and debit value adjustments for netting groups, you need to create the netting groups in the Credit Risk Analyzer under Basic Settings Definitions Define Netting Groups .

Note
Calculation of the CVA and DVA values for netting groups is implemented only for calculation method 2 Based on Expected Exposures.

End of the note.
Calculation of the expected exposures requires a maturity band. You define a maturity band in the area menu of the Market Risk Analyzer under Evaluation Control Define and Set Up Maturity Band (transaction JBRLZB).

Note
The maturity band needs to be long enough to cover the term of the longest financial transaction but preferably not much longer; by defining a maturity band that is just long enough, you reduce the calculation runtime and save memory space.

Within a maturity band, the distances between the grid points can vary. For example, you can first define a frequency of one month, then of one year, and then of five years - within the same maturity band. For the maturity band, you need to select a level of granularity appropriate to the structure of the financial transactions. This means that you generally need to select intervals with finer granularity for shorter terms so that any transactions due to expire shortly are also captured sufficiently. For longer terms, you can select intervals with less fine granularity.

End of the note.

See also: Maturity Band