|
Post by Sapphire Capital on Jul 16, 2008 20:10:36 GMT 4
FX-Adjusted Local Currency Spreads JORGE A. CHAN-LAU Structured and Securitized Products Department, IFC, The World Bank Group; International Monetary Fund (IMF) - Research Department; The Fletcher School of Law and Diplomacy -------------------------------------------------------------------------------- May 2008 Abstract: Changes in domestic and international economic conditions affect partly the trend and volatility of the exchange rate as well as the operating conditions of firms and corporations. Therefore, the common practice of adding up the default risk and currency risk premia could overstate the risk compensation received by investors. Modern approaches to model default risk that incorporate foreign exchange effects while promising may be difficult to implement due to data limitations. This paper addresses the needs of practitioners by presenting a simple rule of thumb, based on the joint dynamics of exchange rate changes and the spreads of credit default swaps, to convert foreign-currency denominated spreads to local currency-denominated spreads adjusting for currency risk. The rule of thumb, while simple, captures the nonlinear dependence between default risk and currency risk, and could be very useful for investors in local currency instruments. papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1132359_code96623.pdf?abstractid=1132359&mirid=3
|
|