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An arbitrage-based risk diagnostic of the cross-currency basis swap

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  • Wise, Richard

Abstract

The cross-currency basis measures the yield differential between the single currency and cross-currency swap markets. The construction of discount curves for the purposes of pricing and risk-managing cross-currency cash flows necessarily incorporates this basis, resulting in a sensitivity to fluctuations in its value. The basis has proved prone to significant volatility twice in the last ten years. More recently, the credit crisis provoked a wave of fixed-income hedge fund de-leveraging which drove the basis to unprecedented levels. This paper derives a quasi-arbitrage pricing diagnostic with respect to the basis. This diagnostic is used to explain some of the empirical drivers of the US dollar–yen spread.

Suggested Citation

  • Wise, Richard, 2008. "An arbitrage-based risk diagnostic of the cross-currency basis swap," Journal of Risk Management in Financial Institutions, Henry Stewart Publications, vol. 2(1), pages 36-46, October.
    • Handle: RePEc:aza:rmfi00:y:2008:v:2:i:1:p:36-46
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    More about this item

    Keywords

    currency basis swap; collateralised loan; Libor; credit-worthiness; convexity;
    All these keywords.

    JEL classification:

    • G2 - Financial Economics - - Financial Institutions and Services
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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