Currency total return swaps: valuation and risk factor analysis |
| |
| Authors: | ROMAIN CUCHET GEORGES HÜBNER |
| |
| Affiliation: | 1. BRD – Groupe Société Générale , Turn BRD – Bd. Ion Mihalache, Sector 1, Bucuresti , 011171 , Romania;2. HEC Management School , University of Liège , Rue Louvrex 14, Bldg N1, B-4000 Liège, Belgium;3. EDHEC Business School , Maastricht University , P.O. Box 616, 6200 MD Maastricht, the Netherlands;4. Gambit Financial Solutions , Rue Forgeur 17 B-4000 Liège, Belgium |
| |
| Abstract: | 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. |
| |
| Keywords: | Credit derivatives Credit risk Currency derivatives Derivative instruments |
|
|
