Hi I haven't understood if I can apply the CVA just for derivatives or I can estimate the PD from CDS spreads and apply these in a bonds portfolio for the CVA calculus. The CVA literature refers to "counterpart risk", but if I use the PD calculated from the CDS spreads I've the "reference entity risk", can I use this one for the CVA/DVA estimations? Thanks, sorry for my banality.
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$\begingroup$ @DavidDuarte gives the right answer, you do not compute CVA on bonds because their price already captures credit risk. The only exception I have seen is if the bonds are part of a repo, then you compute CVA on the repo, which requires taking into account the collateral, which in this case is the bonds. $\endgroup$– Daneel OlivawCommented Jun 11, 2020 at 10:03
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CVA stands for Credit Valuation Adjustment and should be applied to derivatives and not bond portfolios.
The reason is that unlike derivatives, a bond has the counterparty credit quality implicitly priced. Consider two bonds with exactly the same features (coupon, maturity, etc) but issued by a different entity. Most likely, the bonds will have different prices.
The fair price of a derivative on the other hand ignores who the counterparty is, and that is why all the xVAs came abount. They are valuation adjustments to the derivative's fair value to take into account all sorts of costs that the "holder" of a derivative will bear.
So a bond has the counterparty risk implicitly priced and a derivative can have the counterparty risk explicitly priced through CVA/DVA.
answered Jun 11, 2020 at 8:55