Currency total return swaps: valuation and risk factor analysis

Abstract

Currency total return swaps (CTRS) are hybrid derivative instruments that allow us to simultaneously hedge against credit and currency risks. We develop a structural credit risk model to evaluate CTRS premia. An empirical test on a sample of 23,005 price observations from 59 underlying issuers yields an average percentage error of around 10%. This indicates that, beyond interest rate risk, firm-specific factors are major drivers of the variations in the valuation of these instruments. Regression analysis of residuals shows that exchange rate determinants account for up to 40% of model pricing errors, indicating that a currency risk premium affects the CTRS price significantly but only marginally, which confirms the prevalence of credit risk in the pricing of CTRS.     

Social Welfare Functionals on Restricted Domains and in Economic Environments

Arrow's “impossibility” and similar classical theorems are usually proved for an unrestricted domain of preference profiles. Recent work extends Arrow's theorem to various restricted but “saturating” domains of privately oriented, continuous, (strictly) convex, and (strictly) monotone “economic preferences” for private and/or public goods. For strongly saturating domains of more general utility profiles, this paper provides similar extensions of Wilson's theorem and of the strong and weak “welfarism” results due to d'Aspremont and Gevers and to Roberts. Hence, for social welfare functionals with or without interpersonal comparisons of utility, most previous classification results in social choice theory apply equally to strongly saturating economic domains.     

Inefficient Public Provision in a Repeated Elections Model

We consider a dynamic setting with no policy commitment. Two parties that compete for election must choose the level of provision of a public good as well as the tax payment needed to finance it. The cost of producing the good may be high or low and this information is not known to the voters. We show that there exists an equilibrium in which the party that does not want much of the public good uses the inefficient (high cost) technology even though the efficient one is available. Using the low cost technology would, by informing the voters about the cost parameter, force it to produce an excessively high level of the good in the future. Interestingly, this equilibrium is not symmetric, suggesting that a party with a strong taste for the public good is less likely to adopt a wasteful policy.     

Efficiency Tests of the Foreign Currency Options Market

Based on a new options transactions data base from the Philadelphia Stock Exchange Foreign Currency Options Market, this paper examines the importance of the effect of nonsynchronous prices and transaction costs on the usual option market efficiency tests. The tests conducted are based on the transaction cost adjusted early exercise and put-call parity pricing boundaries applicable to the American foreign currency options market. The test results show that the put-call parity boundary tests are sensitive to both nonsynchronous prices and transaction costs. The early exercise boundary tests are sensitive to transaction costs but are not very sensitive to simultaneity of the option price and the underlying spot price. Under the no-transaction costs scenario, a large number of early exercise boundary violations is found even when simultaneous spot and option prices are used. These violations disappear when actual transaction costs are taken into account.     

A NOTE ON THE HIERARCHY–TEAM DEBATE

This note explores the debate between proponents of organizational learning who have criticized hierarchy as an obstacle to learning and those who have defended hierarchy as indispensable for large organizations. By considering hierarchy and team as ideal-typical information systems, it is argued that both teams and hierarchies are essential for organizational learning in large organizations. Teams appear to be the key learning units which are indispensable for producing and understanding novel information, and hierarchies are indispensable for processing and storing important learning results. The trade-off between teams and hierarchy can be solved by emphasizing the idea of circularity, involving the ability to switch between teams and hierarchies as complementary information systems in the context of organizational learning.     

INNOVATION AND MARKET STRUCTURE: AN EMPIRICAL EVALUATION OF THE ‘BOUNDS APPROACH’ IN THE CHEMICAL INDUSTRY*

This paper applies Sutton's [1998] ‘bounds approach’ to the chemical industry. The approach predicts that (i) the lower bound of the ratio of the 1‐firm concentration index to product concentration is bounded away from zero at high levels of product concentration only in high R&D markets and (ii) the lower bound on market concentration is higher and increasing in product concentration in markets with higher R&D intensities. We test these two hypotheses and find that the data strongly support them. A novel feature of our analysis is the use of plant level data in defining products and the classification of products into markets based on end‐use.     

Options on the Spot and Options on Futures

This paper analyzes and compares the valuation of two types of options that relate to the same asset: options on the asset itself and options on the futures on the asset. The early exercise privilege plays a central role in explaining the differences between the values of the two options. It is shown that in the case of a cash instrument that does not make interim payments, such as gold, the value of a call option on the spot is smaller than the call option on the futures contract; the opposite is true for put options. The early exercise boundaries, which characterize when it pays to exercise, are also compared and analyzed.     

Investment in Tourism Market and Reputation

Recent contributions in tourism economics acknowledge that the tourism market is imperfectly competitive and, as such, should be studied from an industrial organization perspective. This approach seems especially relevant to shed lights on one issue of importance for tourism destinations: how to achieve sustainable tourism development? Indeed, it has long been empirically observed that tourism development follows a life cycle. After a period of growth, the development of touristic (mountain and seaside) resorts usually stagnate and decline. At least part of the explanation for this pattern is to be found in the evolution of destinations' reputation over time. The present paper investigates the incentives for adjacent tourist resorts to invest in quality in order to maintain their collective reputation. We propose a dynamic model where (1) several adjacent tourist resorts select their tourist flows and (2) invest in order to remedy to the detrimental effects tourism flows have on local environmental amenities. The overall tourist presence and the sum of investments made by tourist resorts jointly define the quality of the touristic product offered by this tourism destination. We assume that this quality cannot be observed by consumers at the time of purchase. However, in this situation of imperfect information, consumers form expectations about the quality of the touristic product offered at any point of time. These expectations define the collective reputation of tourist resorts, determine the position of the tourist resorts' demand curve and constitute the state variable in the differential game. We characterize and compare equilibrium strategies under a noncooperative and investments coordination regimes.