Dynamic risk management and asset comovement

Søren Bundgaard Brøgger

Journal of Empirical Finance, 2022, vol. 67, issue C, 60-77

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.

Keywords: Derivatives; Risk management; Counterparty risk; Credit default swaps; Credit valuation adjustments (search for similar items in EconPapers)
JEL-codes: G13 G14 G18 (search for similar items in EconPapers)
Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:67:y:2022:i:c:p:60-77

DOI: 10.1016/j.jempfin.2022.01.003

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