Soft Currency Intricacies: OIS Discounting and Quanto Adjustments

Posted: 4 Nov 2013 Last revised: 16 Apr 2018

Vilimir Yordanov

Independent

Date Written: April 1, 2018

Abstract

The paper builds a framework to tackle the intricacies of the OIS discounting and quanto adjustments under soft currency. Compared to the standard case both concepts need certain modifications due to the presence of default risk for the reference entity. This requires the effects of correlation between the default intensity and the exchange rate and the possibility of a jump of the exchange rate at the time of default to be specially considered. A broader treatment of the numeraires employed in pricing and of the whole no-arbitrage setting in general is also needed. Along with the theoretical significance the framework has also a very practical one. Namely, many financial institutions with a focus on emerging markets possess assets denominated in soft currencies and it could be beneficial for them to pose or accept such as collateral. Sometimes this is the only viable option when they are local entities and trade predominantly in local currency. Major emerging markets countries in recent years have developed in accord markets for local currency OIS swaps and there are liquid quotes available. Quanto products as a standard vehicle for investors to gain a hedged access to attractive multi-currency assets are also affected and under focus.

Keywords: exchange rate, yield curve, credit risk, OIS, quanto adjustment

JEL Classification: E43, G12, G13

Suggested Citation

Yordanov, Vilimir, Soft Currency Intricacies: OIS Discounting and Quanto Adjustments (April 1, 2018). Available at SSRN: https://ssrn.com/abstract=2349822

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