The Impact of Currency Movements on Asset Value Correlations
AbstractThis paper looks at the asset correlation bias resulting from firms’ assets and liabilities being denominated in different currencies. It focuses on the time-variation in the bias and on the dependency of the bias on currency movements. Both the volatility of the exchange rate and the correlations between the asset values and the exchange rate affect the bias and we find the sensitivity of the bias to the former to be greatest. Despite this, and as a result of the wide fluctuations of the asset value - exchange rate correlations over the last ten to fifteen years, the asset value - exchange rate correlation’s net effect on the bias is more significant, economically. Overall, we find that the asset correlation bias for the average pair of firms in the Dow Jones Industrial Average index is significant for the better part of the 2000-2013 time period. The bias fluctuates widely, however, and it has turned negative for shorter periods. The policy implication of the paper is that by ignoring the exchange rate component when computing portfolio credit risk one may materially underestimate the actual risk. Particularly at times of frequent and significant exchange rate movements.
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Bibliographic InfoPaper provided by Lund University, Department of Economics in its series Working Papers with number 2013:33.
Length: 17 pages
Date of creation: 02 Oct 2013
Date of revision:
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Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund,Sweden
Phone: +46 +46 222 0000
Fax: +46 +46 2224613
Web page: http://www.nek.lu.se/en
More information through EDIRC
asset correlation; time-variation; sensitivity; exchange rate; currency risk;
Other versions of this item:
- Byström, Hans, 2014. "The impact of currency movements on asset value correlations," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 31(C), pages 178-186.
- F31 - International Economics - - International Finance - - - Foreign Exchange
- G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
- G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-10-18 (All new papers)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Merton, Robert C., 1973.
"On the pricing of corporate debt: the risk structure of interest rates,"
684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
- Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-70, May.
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