Quanto CDS Spreads

91 Pages Posted: 10 Nov 2018

See all articles by David Lando

David Lando

Copenhagen Business School

Andreas Bang Nielsen

Cornerstone Research

Date Written: April 20, 2018

Abstract

Quanto CDS spreads are differences in CDS premiums of the same reference entity but in different currency denominations. Such spreads can arise in arbitrage-free models and depend on the risk of a jump in the exchange rate upon default of the underlying and the covariance between the exchange rate and default risk. We develop a model that separates the contribution of these two effects to quanto spreads and apply it to four eurozone sovereigns. Furthermore, using our model estimates, we provide evidence that quanto effects can explain a significant part of the yield spread between eurozone sovereign bonds issued in Euro and U.S. dollar. Our findings suggest that comparing bond yields across currency denominations using standard FX forward hedges misses an important quanto effect component.

Keywords: Sovereign Credit Risk, CDS Premiums, Currency Risk, Systemic Risk

JEL Classification: G00, G01,G12, G13, H63, F31

Suggested Citation

Lando, David and Bang Nielsen, Andreas, Quanto CDS Spreads (April 20, 2018). Available at SSRN: https://ssrn.com/abstract=3268890 or http://dx.doi.org/10.2139/ssrn.3268890

David Lando

Copenhagen Business School ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark
+45 3815 3600 (Fax)

Andreas Bang Nielsen (Contact Author)

Cornerstone Research ( email )

4 More London Riverside
London, SE1 2AU
United Kingdom

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