Debt (or debit) value adjustment (DVA) is the valuation adjustment that reflects the possibility of a party’s own default on its derivative liabilities. It is the symmetric counterpart of CVA: one party’s CVA cost is the other party’s DVA benefit. DVA arises from the exit-price concept in accounting standards (IFRS 13 and FASB 157), which requires that the fair value of a liability include the effect of the entity’s own credit risk (non-performance risk).
DVA is economically problematic because it appears on a bank’s balance sheet as a profit that increases as the bank’s credit quality deteriorates. Since the benefit is contingent on the bank’s own default, it depreciates through time decay if the bank does not actually default. Furthermore, Basel III capital requirements explicitly disallow DVA accounting benefits from Common Equity Tier 1 capital, creating a conflict between accounting standards (which require DVA) and regulatory rules (which exclude it).
There is also a well-known overlap between DVA and the funding benefit adjustment (FBA), the beneficial component of FVA. Own-default risk is widely seen as being economically equivalent to a funding benefit, since a party that can default on its obligations effectively borrows at a spread that compensates lenders for this default risk. This overlap is a central issue in the consistent formulation of xVA.
Key Details
- DVA is a benefit (positive adjustment) from the perspective of the party whose own default it reflects.
- Accounting standards (IFRS 13, FASB 157) require DVA; Basel III disallows its contribution to regulatory capital.
- DVA is “probably so unreal as to be considered inapplicable” (Gregory, p. 92) from a purely economic standpoint.
- The overlap between DVA and FBA is a key theoretical issue: if both are included, there is potential double-counting.
Textbook References
The xVA Challenge (Gregory, 2020)
- Section 5.3.3 (pp. 96—97): IFRS 13 states “the fair value of a liability reflects the effect of non-performance risk” and FASB 157 requires “the effect of its credit risk (credit standing) on the fair value of the liability”. This mandates DVA. However, DVA is problematic: it produces a profit when credit quality deteriorates.
- Section 5.3.3 (p. 97): Basel III (BCBS 2011d) requires derecognition of “all unrealised gains and losses that have resulted from changes in the fair value of liabilities that are due to changes in the bank’s own credit risk” from CET1 capital.
- Section 3.2.3 (pp. 56—57): DVA represents counterparty risk from the point of view of a party’s own default. It is distinct from FBA, though there are potential overlaps.
- Section 16.3.2 (p. 482): DVA is defined as being specific to own default, as distinct from being a funding benefit.
- Section 17.3.1 (pp. 498—499): Accounting background for DVA. FAS 157 (2006) led US/Canadian banks to report DVA; IFRS 13 (2013) brought broader adoption. DVA is associated with ENE in the same way CVA is associated with EPE.
- Section 17.3.2 (pp. 499—500): DVA and price symmetry. With CVA_A = -DVA_B and DVA_A = -CVA_B, bilateral valuations agree. The shareholder vs bondholder view: shareholders receive nothing in default (DVA is not “real” to them); bondholders benefit from higher recovery. Regulation (focused on shareholder equity) derecognises DVA.
- Section 17.3.3 (pp. 500—502): bilateral CVA formula. DVA(t) = -LGD_P integral lambda_P D_{r+lambda_C+lambda_P}(t,u) ENE(t,u) du (Eq. 17.7c). Discrete form: DVA = -LGD_P sum ENE(t_i) PD_P(t_{i-1},t_i) [1-PD_C(0,t_{i-1})] (Eq. 17.8b).
- Section 17.3.5 (pp. 503—506): The use of DVA. Attempts to monetise DVA: defaulting (impractical), unwinds/novations (replacement cost offsets benefit), close-out claims (legally uncertain), hedging by selling CDS on correlated names (creates systemic risk). DVA is derecognised from regulatory capital. Market practice is divided on DVA in pricing (Figure 17.11); most Totem submissions show no DVA component.
- Section 18.2.5 (pp. 539—541): DVA as a funding benefit. The Burgard-Kjaer framework derives DVA = -LGD_P integral lambda_P D ENE du (Eq. 18.6), equivalent to FBA when the credit spread equals the funding spread (FS = LGD_P x lambda_P). To avoid double-counting: either CVA + FCA + FBA (symmetric funding, replaces DVA with FBA) or CVA + DVA + FCA (bilateral, asymmetric funding).