Journal of Risk

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Currency dependence of corporate credit spreads

Rainer Jankowitsch, Stefan Pichler

ABSTRACT

Many pricing and risk management models require credit spread curves as an input. Given the small number of bonds outstanding per issuer, the estimation of credit spread curves in the corporate bond market is not a trivial matter. In many cases, to ensure that one has a sufficient number of bonds for the estimation procedure it is necessary to use bonds issued in different currencies, which means that the estimation procedure has to take into account potential currency effects. Using a rather general pricing framework, we show that credit spreads for a particular issuer are expected to be equal across different currencies only if the correlation between the default variables and the exchange rates and relevant money market accounts is zero. We present a new model that makes it possible to estimate a credit spread curve for a single issuer with bonds in different currencies and which simultaneously allows testing for the existence of currency-related effects. This new model is based on the multicurve estimation approach, which allows a parsimonious joint estimation of a risk-free term structure and the credit spread curve of the issuer. We reject the hypothesis of zero correlation between credit risk and exchange rate and interest rate risk, respectively. We present empirical evidence that there are significant differences between issuer-specific credit spreads across different currencies in a representative sample of international corporate bonds. Moreover, this implies that dollar-related credit spread curves cannot be used without paying special attention to the pricing of defaultable claims denominated in other currencies.

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