Credit/Debit Value Adjustment - Accounting Voodoo?

The continuing financial crisis has led to significant changes in the valuation of derivatives contracts. Fair value continues to be one of the key issues for the banking sector. Risk-free world or real world?
This discussion is influenced by technology.

New accounting standards force the adjustment of credit values (CVA) or even more controversial debit values (DVA) - DVA allows an institution to report profit as its health deteriorates ....

However, the adjustments need to rely on exposure modeling, the prediction of future cash flows of a portfolio with a counter party - if you combine both, CVA/DVA bilateral both directions and the net cash flows.

This introduces much more complexity in the valuation space, relevant to trading, risk management and accounting.

UnRisk is a valuation and risk management technology and we have already shown that, for example, the calculation of Monte Carlo VaRs with full valuation for a moderately complex portfolio needs enormous computing muscles and optimized numerical schemes for the over night valuation.
And this is what we do - make blazingly fast valuation engines and drive them over computer grids.

With CVA/DVA bilateral one may run into requirements of billions of single valuations for portfolios with a major counter party and general derivatives.

One result: with the momentary technologies it seems impossible to leave the risk-free world and the application of Libor market models for complex interest rate derivatives is questionable (the short rate models are dead - long live the short rate models?).

Not to speak of model validation and other extra tests ....

Oh yes, mathematical-finance difference and clever implementations really matter. And without bottom-up innovation it is impossible to keep pace with the requirements introduced by financial regulators.

About our 2013 Agenda.