Comparing Alternate Methods for Calculating CVA Capital Charges Under Basel III
The global financial crisis brought counterparty credit risk and CVA very much into the spotlight. The Basel III proposals, first published in December 2009, introduced changes to the Basel II rules that reflected the need for a new capital charge against the volatility of CVA.

There are two ways for banks to compute CVA VaR, standardised and advanced methods, depending on their current regulatory approval. Furthermore, firms can potentially reduce the capital charges via eligible hedges. This paper reviews the two regimes by:

  • Describing and comparing the various methodologies for calculating counterparty credit risk capital under Basel regulations
  • Analysing these methods in detail and demonstrating that both standardised and advanced formulas can be interpreted as 99% VaR of losses due to CVA volatilities; thus simple comparative analysis can be done based on CVA volatilities and correlations implied by the methods
  • Running simple tests for three methods: standardised (CEM), standardised (IMM) and advanced to investigate which one performs better for various maturities and different types of counterparties
  • Analysing results for a real portfolio and highlighting that the difference in capital between the simple and more advanced approaches when considering hedging can be significant

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