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Currency Total Return Swaps: Valuation and Risk Factor Analysis

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  • Romain Cuchet
  • Pascal François
  • Georges Hübner

Abstract

Currency total return swaps (CTRS) are hybrid derivatives instruments that allow to simultaneously hedge against credit and currency risks. We develop a structural credit risk model to evaluate CTRS premia. 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.

Suggested Citation

  • Romain Cuchet & Pascal François & Georges Hübner, 2011. "Currency Total Return Swaps: Valuation and Risk Factor Analysis," Cahiers de recherche 1128, CIRPEE.
    • Handle: RePEc:lvl:lacicr:1128
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    References listed on IDEAS

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    More about this item

    Keywords

    Credit derivative; credit risk; currency risk;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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