Pricing fx Forwards in OTC Markets

A. Leonhardt, Andreas W. Rathgeber, J. Stadler and Stefan Stöckl
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Andreas W. Rathgeber: UNIA - Universität Augsburg [Deutschland] = University of Augsburg [Germany] = Université d'Augsburg [Allemagne]
J. Stadler: 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: By using daily foreign exchange (fx) market data for five major currency pairs, this article shows that, especially since the beginning of the financial crisis, pricing of fx forwards has not matched the pricing formula derived from the covered interest rate parity (CIP). This corresponds to previous empirical results. Therefore, the CIP leads to systematic over- or underpricing. Overall, four statistically significant explanatory factors for this systematic over- or underpricing have been identified – the volatility in the difference between the interest rate levels, the spot price, the fx forward spread and the counterparty risk. In particular, the high significance of the counterparty risk demonstrates that pricing models for fx forwards should be reviewed.

Keywords: counterparty risk; market microstructure; OTC markets; pricing fx forwards; risk premium (search for similar items in EconPapers)
Date: 2015
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Published in Applied Economics, 2015, 47 (25-27), pp.2860 - 2877. ⟨10.1080/00036846.2015.1011309⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-01371713

DOI: 10.1080/00036846.2015.1011309

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