FX-Adjusted Local Currency Spreads

Download or read book FX-Adjusted Local Currency Spreads written by Jorge A. Chan-Lau and published by . This book was released on 2008 with total page 14 pages. Available in PDF, EPUB and Kindle. Book excerpt: 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.