TY - JOUR
T1 - Covered interest parity deviation and counterparty default risk
T2 - U.S. Dollar/Korean Won FX swap market
AU - Choi, Hanbok
AU - Eom, Young Ho
AU - Jang, Woon Wook
AU - Kim, Don H.
N1 - Publisher Copyright:
© 2017 Elsevier B.V.
PY - 2017/9
Y1 - 2017/9
N2 - We investigate how much of the observed CIP (covered interest parity) deviation in the U.S. Dollar/Korean Won FX (foreign exchange) swap markets during the financial crisis can be explained by credit risk. To this end, we develop a structural model of defaultable FX swaps, applying the approach of Coval et al. (2009a, 2009b) to the FX setting. Calibrating the model to Korean banks and U.S. banks, we find that significant portions of the CIP deviation in the U.S. Dollar/Korean Won FX swaps can be explained by counterparty risk; most of this effect is due to the counterparty risk of Korean banks (as opposed to U.S. banks). The influence of counterparty default risk is pronounced particularly for the period after the default of Lehman Brothers.
AB - We investigate how much of the observed CIP (covered interest parity) deviation in the U.S. Dollar/Korean Won FX (foreign exchange) swap markets during the financial crisis can be explained by credit risk. To this end, we develop a structural model of defaultable FX swaps, applying the approach of Coval et al. (2009a, 2009b) to the FX setting. Calibrating the model to Korean banks and U.S. banks, we find that significant portions of the CIP deviation in the U.S. Dollar/Korean Won FX swaps can be explained by counterparty risk; most of this effect is due to the counterparty risk of Korean banks (as opposed to U.S. banks). The influence of counterparty default risk is pronounced particularly for the period after the default of Lehman Brothers.
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U2 - 10.1016/j.pacfin.2017.05.002
DO - 10.1016/j.pacfin.2017.05.002
M3 - Article
AN - SCOPUS:85033213254
SN - 0927-538X
VL - 44
SP - 47
EP - 63
JO - Pacific Basin Finance Journal
JF - Pacific Basin Finance Journal
ER -