Overview
The price of a loan with credit risk, (that is a loan that could default), is less than the price of an identical loan with no credit risk. The difference is termed the CVA, or credit value adjustment.
{% RiskyValue = RiskFreeValue - CVA %}
CVA is a factor in a more general framework, sometimes know as
XVA.
The term CVA is primarily used in the context of derivatives. Fixed Income often will refer to this as Expected Credit Loss, although they are eseentially the same. The XVA framework provides a simple way to discuss adjustments to any financial instrument.
Measurement and Modeling
Given a random variable {% L %} representing the loss on a given loan due to default, standard financial theory would suggest that
{% CVA \geq \mathbb{E}(L) ? %}
For information about modeling the credit loss, see
credit risk models
Rearranging terms, we get
{% Excess = CVA - \mathbb{E}(L) ? %}
According to the
The excess price of credit risk over and above the expected value is due to correlation to market risk
(see Capital Asset Pricing Model)