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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.
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Richard Wise was educated at Cambridge University, graduating with a double first in mathematics in 1990. He worked at the regulatory forbearer of the UK Financial Services Authority, the Securities and Futures Authority, as a risk analyst before joining JP Morgan Chase in 1995. He has worked in various roles at JP Morgan including being an interest rate derivative trader in the London office prior to relocating to Japan. He has spent the last seven years in Japan building the market risk management function for Asia-Pacific. He is now in a global role heading risk management for the institutional equities business of JP Morgan.
CitationWise, Richard (2008, October 1). An arbitrage-based risk diagnostic of the cross-currency basis swap. In the Journal of Risk Management in Financial Institutions, Volume 2, Issue 1.