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Currency total return swaps: valuation and risk factor analysis

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  • ROMAIN CUCHET
  • PASCAL FRAN�OIS
  • GEORGES H�BNER

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.

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File URL: http://hdl.handle.net/10.1080/14697688.2013.775475
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Bibliographic Info

Article provided by Taylor & Francis Journals in its journal Quantitative Finance.

Volume (Year): 13 (2013)
Issue (Month): 7 (February)
Pages: 1135-1148

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Handle: RePEc:taf:quantf:v:13:y:2013:i:7:p:1135-1148

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  1. Gaiyan Zhang & Jot Yau & Hung-Gay Fung, 2010. "Do credit default swaps predict currency values?," Applied Financial Economics, Taylor & Francis Journals, vol. 20(6), pages 439-458.
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