Credit Risk Management Practice Exam

In stress testing, which variables are commonly considered for calculating stressed CVA?

1. The default rates and recovery rates only

2. The historical performance data exclusively

3. Market variables like credit spreads and derivatives values

4. Only counterparty probabilities of default

The correct answer is: Market variables like credit spreads and derivatives values

In stress testing, the calculation of stressed Credit Valuation Adjustment (CVA) is crucial for understanding potential losses in adverse market conditions. The correct choice highlights the importance of considering market variables such as credit spreads and derivatives values. Credit spreads provide insight into the perceived credit risk associated with a counterparty. An increase in credit spreads indicates a deterioration in credit quality, thereby affecting the CVA. Derivatives values, on the other hand, fluctuate based on market conditions and counterparty creditworthiness. Including these variables allows a comprehensive view of how the market environment can impact credit exposure and potential losses during adverse scenarios. This approach ensures that the stress testing captures the dynamics of the financial environment, reflecting realistic conditions that could lead to significant losses. It underscores the importance of integrating both counterparty-specific probabilities and broader market indicators when assessing credit risk.