How CVA Desk Pricing Relates to Hedge Costs and Internal Charges

Summary

The note explains what a CVA desk’s trade value means in the context of counterparty credit risk. It cautions that the NPV of a hedge, such as buying a credit default swap on a counterparty, is not itself a measure of the desk’s profit: like other derivatives, the hedge typically starts at zero value. CVA and DVA contribute to the valuation adjustment on the underlying trade, but this does not mean an XVA trade’s NPV directly represents earnings.

Instead, the desk may earn revenue by charging the originating internal desk more than the cost of its hedge. The example describes charging an internal rate above the market cost of the CDS to cover transaction expenses and rebalancing risk. This is a simplified explanation of internal transfer pricing; it does not detail valuation models, capital costs, hedge effectiveness, or how realized profits may differ from the initial charge.

Key ideas

• A CVA hedge’s initial NPV does not by itself indicate the desk’s expected profit.
• A typical counterparty credit hedge may involve buying a CDS referencing the counterparty.
• CVA desks can charge internal desks more than the market cost of the hedge.
• The added charge can account for transaction costs and rebalancing risk.
• CVA and DVA are valuation adjustments, while desk earnings depend on pricing and costs.

Tags

# What does the NPV of a CVA trade tell you


# What does the NPV of a CVA trade tell you












From the perspective of an XVA desk, what does the NPV actually tell you in terms of Counter-party Credit Risk? I understand that CVA + DVA gives you the NPV of any given trade (at the simplest level), But what does that mean? As an example, if I have an underlying trade of an interest-rate swap and the XVA desk decides to place a CVA trade on this interest rate swap because they think one of the counter-parties involved is at a high default risk, Does the NPV of the child trade (XVA) show that the XVA desk will profit or is it more of a gauge of what they can charge the rates desk internally? Sorry if this is the wrong forum for this but I’m trying to wrap my head around how these Desks make money and what positive CVA/DVA actually correlate to.

## Answer by dm63 (score 2)

https://quant.stackexchange.com/a/71199

The NPV of a trade done by the CVA desk seems like a red herring. After all, a typical trade done by them is to buy a CDS on the counter party as reference entity, but like all derivatives trades this starts at zero value.

CVA desks make money by charging internal desks a little bit more than the cost of their hedge. For example if the CDS of the counterparty trades at 100bp, perhaps they charge the internal desk 110bp, to account for transaction costs and rebalancing risk.

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