Estimation of Currency Swap Yield Curve

Doruk Küçüksaraç, Abdullah Kazdal and Ibrahim Ethem Guney

CBT Research Notes in Economics from Research and Monetary Policy Department, Central Bank of the Republic of Turkey

Abstract: [EN] Currency swap is a financial derivative that allows parties to transform assets or liabilities denominated in one currency into another one. This product has been widely utilized in global financial markets in order to manage foreign exchange liquidity and to conduct carry trade transactions. Besides, central banks and investors follow currency swap market for the purposes of valuing financial derivatives, estimating counterparty risk and inferring about monetary policy stance. Currency swap transactions have substantial amount of volume in Turkey and they are extensively used by the banks. Given its frequent use, it is crucial to interpret the information related to currency swap rates. However, currency swap rates are quoted as par-rate, which is the coupon rate that makes the value of all cash flows equal to the face value, and their interpretation is not straightforward. This note employs one of the most popular parametric methods, Nelson-Siegel model, for currency swap rates to form a zero-coupon currency swap yield curve. In this regard, we provide an approach to convert the quoted currency swap rates to zero-coupon currency rates. The estimation results show that the fitted and quoted currency swap rates are quite close to each other. Additionally, the zero-coupon swap rates are compared with forward implied rates for specific maturities since both products are quite similar in nature. Both rates are observed to move together, which shows the consistency of our estimations. Overall, we believe that the approach we adopt in this study provides a useful tool for investors and regulatory authorities.

Date: 2018
New Economics Papers: this item is included in nep-ara and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:tcb:econot:1803

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