Abstract
When dealers’ hedging demand in one market depends on movements in another market it can drive a correlation between returns in the two markets. I show that changes in dealers’ demand for CDS protection for the purpose of counterparty risk management induce a non-fundamental correlation between credit and currency markets. The effects are economically significant. For example, I show that counterparty risk hedging associated with SoftBank’s currency swap portfolio substantially lowers the correlation between SoftBank’s CDS spread and the USD/JPY exchange rate and accounts for around 25% of the weekly volatility of CDS returns.
Original language | English |
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Journal | Journal of Empirical Finance |
Volume | 67 |
Issue number | 44 |
Pages (from-to) | 60-77 |
Number of pages | 18 |
ISSN | 0927-5398 |
DOIs | |
Publication status | Published - Jun 2022 |
Bibliographical note
Published online: 31 January 2022.Keywords
- Derivatives
- Risk management
- Counterparty risk
- Credit default swaps
- Credit valuation adjustments