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Asian Review of Financial Research, Vol., No..
pp.219~252
pp.219~252
Covered Interest Parity Deviation and Counterparty Default Risk : US Dollar / Korean Won FX Swap Market
Hanbok Choi Woori Investment & Securities
Young Ho Eom Yonsei University
Woon Wook Jang Yonsei University
Don H. Kim Board of Governors of the Federal Reserve System
We investigate how much of the CIP (covered interest parity) deviation ob- served in FX swap markets during the ?nancial crisis can be explained by credit risk. To this end, we develop a structural model of defaultable FX swaps, applying the approach of Coval et al (2009a,b) to the FX setting. Calibrating the model to the CDS spreads of Korean banks and US banks, we ?nd that as much as 65% of the CIP deviation in the US Dollar / Korean Won FX swaps can be explained by counterparty risk; most of this e¢´ect is due to the counterparty risk of Korean banks (as opposed to US banks). The in?uence of counterparty default risk is pronounced especially for the period after the default of Lehman Brothers.
Hanbok Choi
Young Ho Eom
Woon Wook Jang
Don H. Kim4
We investigate how much of the CIP (covered interest parity) deviation ob- served in FX swap markets during the ?nancial crisis can be explained by credit risk. To this end, we develop a structural model of defaultable FX swaps, applying the approach of Coval et al (2009a,b) to the FX setting. Calibrating the model to the CDS spreads of Korean banks and US banks, we ?nd that as much as 65% of the CIP deviation in the US Dollar / Korean Won FX swaps can be explained by counterparty risk; most of this e¢´ect is due to the counterparty risk of Korean banks (as opposed to US banks). The in?uence of counterparty default risk is pronounced especially for the period after the default of Lehman Brothers.
Arrow-Debreu state price,FX swap,Counterparty default risk,CIP deviation,FX risk premium
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