Explanation:
Debt Value Adjustment (DVA) accounts for the institution's own credit risk and is added to CVA to compute Bilateral CVA. Wrong-way risk (WWR) is the adverse correlation between exposure and the counterparty's default probability. Capturing WWR requires adjusting the expected exposure to be conditional on the counterparty's default or modeling the joint dynamics of market variables and default probability, rather than adding a DVA term. Therefore, statement B is false. Regarding statement D, a 5-year life with 3-month intervals results in exactly 5 * 4 = 20 calculation points.
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708.2. The formula below is given by Lynch as the simplified formula for credit value adjustment (CVA):
If this CVA formula is applied to a single derivative instrument with a five (5) year life, and the interval between dates, , is three months, then each of the following statements is true EXCEPT which is false?
A
Stressed CVA is likely to shock EE(n) to the stressed expected exposure, EE(n)^s
B
To capture wrong-way risk, the formula should add a debt value adjustment (DVA) term
C
Stressed CVA is likely to shock q(n) to the stressed risk-neutral marginal default probability, q(n)^s
D
The expected exposure and default probability will be estimated at twenty (20) points in time
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