Pricing Anomaly at the First Sight: Same Borrower in Different Currencies Faces Different Credit Spreads―An Explanation by Means of a Quanto Option

Andreas W. Rathgeber, David Rudolph and Stefan Stöckl
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Andreas W. Rathgeber: University for Medical Information Technology (UMIT)
David Rudolph: UNIA - Universität Augsburg [Deutschland] = University of Augsburg [Germany] = Université d'Augsburg [Allemagne]
Stefan Stöckl: CEREFIGE - Centre Européen de Recherche en Economie Financière et Gestion des Entreprises - UL - Université de Lorraine, ICN Business School

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Abstract: Can the credit spreads of one and the same issuer differ in two different currencies? If so, can an investor exploit this situation? To answer these questions and to contribute to the existing literature, we extend the Jarrow/Turnbull-model with a second currency, price a quanto option, and test the theoretical results with an extensive empirical study. A major result of the study was the key insight that the credit spreads, and therefore the cumulated implied default probabilities of nearly all bonds denominated in USD in comparison to EUR denominated bonds, are significantly higher for all terms, and are mostly driven by the correlation between default risk and exchange rate.

Keywords: Credit spreads Efficient market hypothesis; Foreign currency government bonds; Implied default probabilities; Term structure of interest rate (search for similar items in EconPapers)
Date: 2015
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Published in Review of Derivatives Research, 2015, 18 (2), pp.107 - 143. ⟨10.1007/s11147-014-9106-z⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-01371712

DOI: 10.1007/s11147-014-9106-z

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