Explanation:
Stress testing Credit Valuation Adjustment (CVA) requires analyzing two distinct types of risk:
Because counterparty credit risk and CVA hedging exhibit non-linearities and portfolio-level netting/diversification effects, risk must be assessed at both the individual counterparty level and the aggregate portfolio level. For 5 counterparties, calculating both market and credit risk requires 5 × 2 = 10 values. Calculating both market and credit risk for the aggregate portfolio requires an additional 1 × 2 = 2 values. In total, Rick must present at least 12 values.
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707.2. Rick is the bank's Credit Counterparty Risk (CCR) Manager, and he is preparing a stress test report for a credit portfolio that includes positions with five major counterparties. In addition to default risk and credit deterioration, each of these positions does expose the bank to fluctuations in its credit valuation adjustment (CVA). Because the stress test report will be presented to the bank's Chief Risk Officer (CRO), Rick wants to summarize all relevant values, but he does not want to show more values than necessary. Which of the following is the MOST LIKELY number of values (i.e., stress test results) that he will need to present in his report?
A
One value for the aggregate portfolio
B
Six values: one for the credit risk of each counterparty plus one for credit risk of the portfolio
C
Ten values: for each counterparty, both market and credit risk (but overall portfolio values will be superfluous)
D
At least twelve values: both credit risk and market risk of each counterparty plus the portfolio
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