Measuring Risk to Hedge CVAs

The market volatility experienced during the 2008 financial crisis has driven many firms to review their methods of accounting for counterparty credit risk.

The traditional approach of controlling counterparty credit risk has been to set limits against future exposures and verify potential trades against these limits. Credit Value Adjustment (CVA) offers an opportunity for banks to move beyond the control mindset of limits by dynamically pricing counterparty credit risk directly into new trades.

Many banks already measure CVA in their accounting statements, but the financial crisis has led pioneering banks to invest in systems that more accurately assess CVA, and integrate CVA into pre-deal pricing and structuring. Their expected return on investment is the ability to support future growth by freeing up more capital and minimizing earnings volatility.

But how do you quantify these risks? How, for example, do you measure reputation risk?

In Douglas W. Hubbard’s book, "How to Measure Anything," he defines risks like these and lays out helpful ways to think about quantification. Without that, trying to manage these risks is impractical at best. At worst, it’s a foolish waste of time that does no more than check a box.

Beyond the Box

Arguably, going “outside the box” may not be required in order to employ leading practices in the realm of risk management and regulatory compliance. It is almost certain, however, that managers move beyond the mentality of simply “checking the box.” That is, merely doing anything just to “get it done” will leave the company in an undesirable state. At the very least, managers and employees will be without direction; more than likely, they will go astray and incur even risk without benefit.

Using a proprietary assessment tool, Grayline helps companies evaluate and rank the state of their internal risk measurement and reporting. Contact us today for a complimentary assessment.


Print Friendly and PDF