Basel CVA VaR and Wrong-Way Risk Dependence

Summary

The document raises a question about how Basel III CVA VaR treats credit spreads when counterparty credit risk is dependent on market factors, a relationship often described as wrong-way risk or right-way risk. It notes that the cited framework limits CVA VaR changes to counterparty credit spreads and excludes direct sensitivity to changes in other market variables, such as an underlying asset, commodity, currency, or interest rate.

The central issue is whether spread changes should be modeled conditionally on those market factors or whether the model should impose independence. The document gives no proposed method, evidence, or regulatory answer; it frames an open question about current industry practice and regulators’ interpretation. Any conclusion would require consulting applicable Basel guidance and supervisory expectations, which are not included here.

Key ideas

• Basel III CVA VaR is described as focusing on changes in counterparty credit spreads.
• The document asks how this restriction applies when credit spreads depend on market factors.
• It distinguishes possible conditional modeling from an assumption of independence.
• No answer or supporting evidence about industry practice or regulatory views is provided.

Tags

# Basel CVA VaR with R/WWR


# Basel CVA VaR with R/WWR












In Basel III the CVA VaR “is restricted to changes in the counterparties’ credit spreads and does not model the sensitivity of CVA to changes in other market factors, such as changes in the value of the reference asset, commodity, currency or interest rate of a derivative.”

So, in the general dependent case (WWR/RWR), shall spread changes then be conditioned on market factors or independence be forced? Asking for both current practice and regulators' view...

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.