Modelling credit risk: currency dependence in global credit markets

Alec N. Kercheval, Lisa R. Goldberg, and Ludovic Breger

We investigate credit spreads for euro-, sterling-, and US dollar-denominated credit instruments relative to their local swap curves, and show that spread changes are strongly currency-dependent during the study period May 1999 to May 2001. Sector-by-rating factor returns are at best weakly correlated across currencies, and U.S. dollar spread return volatilities are generally higher than the other two by a factor of two or three. This is contrary to what would be expected from covered interest arbitrage.

This analysis indicates that credit factor risk models in each of the three markets should be estimated separately, and risk forecasting models using a single set of spread factors to cover more than one of these markets will suffer from poor forecasting accuracy.