Overview

A clean derivative price assumes the promised cash flows are paid. Counterparty valuation asks which promises fail, how large the claim is in those states, and whether offsetting trades alter the settlement. This topic converts the exposure/default ledger into a value adjustment and then challenges the independence and trade-by-trade shortcuts.

By the end of this note you should be able to:

• derive clean value minus CVA plus DVA;
• compute an independence benchmark with incremental first-default probabilities;
• measure the error caused by exposure/default dependence;
• apply netting before taking positive parts.

1. Contents
2. The big picture