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Pricing anomaly at the first sight: same borrower in different currencies faces different credit spreads—an explanation by means of a quanto option

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  • Andreas Rathgeber
  • David Rudolph
  • Stefan Stöckl

Abstract

Can the credit spreads of one and the same issuer differ in two different currencies? If so, can an investor exploit this situation? To answer these questions and to contribute to the existing literature, we extend the Jarrow/Turnbull-model with a second currency, price a quanto option, and test the theoretical results with an extensive empirical study. A major result of the study was the key insight that the credit spreads, and therefore the cumulated implied default probabilities of nearly all bonds denominated in USD in comparison to EUR denominated bonds, are significantly higher for all terms, and are mostly driven by the correlation between default risk and exchange rate. Copyright Springer Science+Business Media New York 2015

Suggested Citation

  • Andreas Rathgeber & David Rudolph & Stefan Stöckl, 2015. "Pricing anomaly at the first sight: same borrower in different currencies faces different credit spreads—an explanation by means of a quanto option," Review of Derivatives Research, Springer, vol. 18(2), pages 107-143, July.
    • Handle: RePEc:kap:revdev:v:18:y:2015:i:2:p:107-143
    DOI: 10.1007/s11147-014-9106-z
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    More about this item

    Keywords

    Credit spreads; Efficient market hypothesis; Foreign currency government bonds; Implied default probabilities ; Term structure of interest rate; G12; G13; G15;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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