Duration Approach

CVA = MtM * Credit Spread * Duration

 

Duration is a measure that quantifies the sensitivity of the fair value of a derivative to IR movements.

This approach uses duration to measure how much the fair value of the derivative changes by applying the credit spread to the risk free valuation.

The CVA calculation utilises the counterparty credit spread, while for DVA own credit spread is used. 

 

Duration = PV weighted average time of the CFs.

Advantages: 

- simple methodology can quickly determine if adjustment is likely tobe material and therefore warrants further attention

- can be applied on transaction level and counterparty level 

 

Disadvantages: 

- does not account for potential future exposure 

- does not consider bilateral nature of derivatives  

- not considered best practice 

 

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