Cross-currency Basis Swap Research Articles

Closed Form Approximation of Swap Exposures

This paper provides closed form lower and upper bounds for the price of European swaption on cross currency basis swap with the presence of dynamic basis spreads. Cross currency basis spreads are treated as integrals of spot spreads, approach familiar from interest rate models. The spot spread is modelled by two-factor mean reverting Gaussian model that is equivalent to two-factor Hull-White model introduced by [Hull and White(1994)]. This model allows closed form approximations and relatively well fitting and simple calibration to the spread term structure.

Non-Martingale Dynamics for Two Curve Derivatives Pricing

Given a forwarding LIBOR-style curve F corresponding to a fixed tenor (e.g. 6m) and an exogenous discounting curve D (e.g. an OIS curve or cross-currency basis swap curve) we build on Bianchetti's results to propose dynamics for the forward LIBOR-style rate collateralized by D.In contrast with what other authors do (Bianchetti, Mercurio, Fujii, et al.) we do not assume that the collateralized forward rate is a martingale process under the corresponding forward risk neutral measure associated with the discount process. At time zero the collateralized forward rate is the forwarding curve rate multiplied by a quanto adjustment, but at reset time the expectation of the collateralized forward aligns with the forwarding curve rate.In order to calculate the quanto adjustment we show how to construct a deterministic drift, which can be computed with the information available at time zero by bootstrapping (under certain assumptions on the spot swap rates). We extend the result to forward swap rates in the context of swap market models.

Price Discovery from Cross-Currency and FX Swaps: A Structural Analysis

This paper investigates the relative role of price discovery between two long-term swap contracts that exchange U.S. dollars for Japanese yen - the cross-currency basis swap and the foreign exchange (FX) swap - using structural state space models. Our main findings are that: (i) the currency swap market plays a much more dominant role in price discovery than the FX swap market; and (ii) FX swap prices tend to under react to changes in the efficient price, while cross-currency swap prices react almost entirely to them.

An arbitrage-based risk diagnostic of the cross-currency basis swap

The cross-currency basis measures the yield differential between the single currency and cross-currency swap markets. The construction of discount curves for the purposes of pricing and risk-managing cross-currency cash flows necessarily incorporates this basis, resulting in a sensitivity to fluctuations in its value. The basis has proved prone to significant volatility twice in the last ten years. More recently, the credit crisis provoked a wave of fixed-income hedge fund de-leveraging which drove the basis to unprecedented levels. This paper derives a quasi-arbitrage pricing diagnostic with respect to the basis. This diagnostic is used to explain some of the empirical drivers of the US dollar–yen spread.