Financial Glossary
Credit Valuation Adjustment (CVA)
Credit valuation adjustment (CVA) is the difference between the risk-free value of a contract, typically a derivative, and its value after accounting for the possibility that the counterparty defaults before settling. In effect it is the market price of counterparty credit risk, reducing the reported value of an exposure to reflect expected loss from default. CVA is calculated from the counterparty's probability of default, the expected exposure over the contract's life, and the loss given default.
Problem & Application
While CVA is mostly a concern for banks and firms with large derivative books, the underlying idea, discounting the value of a receivable or contract for the chance the other side cannot pay, applies to any business carrying significant counterparty exposure. Understanding the concept helps a finance team reason about why a contractual claim is worth less than its face amount when the counterparty is shaky. For most owner-operated businesses, the analogous discipline is reserving against doubtful receivables rather than full CVA modeling.
In Short
CVA quantifies what counterparty default risk costs you against the headline value of a contract. The same logic underpins prudent reserving against any claim that may not be paid in full.