Currency Total Return Swaps: Valuation and Risk Factor Analysis

38 Pages Posted: 3 Jun 2011

See all articles by Romain Cuchet

Romain Cuchet

Barclays Corporate Banking

Pascal Francois

HEC Montreal - Department of Finance

Georges Hübner

HEC Liège

Date Written: June 2, 2011

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.

Keywords: Credit derivative, credit risk, currency risk

JEL Classification: G13, G15, G32

Suggested Citation

Cuchet, Romain and Francois, Pascal and Hübner, Georges, Currency Total Return Swaps: Valuation and Risk Factor Analysis (June 2, 2011). Available at SSRN: https://ssrn.com/abstract=1857055 or http://dx.doi.org/10.2139/ssrn.1857055

Romain Cuchet

Barclays Corporate Banking ( email )

1 Churchill Place
London, E14 5HP
United Kingdom
+44 (0)2071161175 (Phone)

Pascal Francois (Contact Author)

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada
514-340-7743 (Phone)
514-340-5632 (Fax)

Georges Hübner

HEC Liège ( email )

Rue Louvrex 14, Bldg. N1
Liege, 4000
Belgium
+32 42327428 (Phone)

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