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Dynamic risk management and asset comovement

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  • Brøgger, Søren Bundgaard

Abstract

When dealers’ hedging demand in one market depends on movements in another market it can drive a correlation between returns in the two markets. I show that changes in dealers’ demand for CDS protection for the purpose of counterparty risk management induce a non-fundamental correlation between credit and currency markets. The effects are economically significant. For example, I show that counterparty risk hedging associated with SoftBank’s currency swap portfolio substantially lowers the correlation between SoftBank’s CDS spread and the USD/JPY exchange rate and accounts for around 25% of the weekly volatility of CDS returns.

Suggested Citation

  • Brøgger, Søren Bundgaard, 2022. "Dynamic risk management and asset comovement," Journal of Empirical Finance, Elsevier, vol. 67(C), pages 60-77.
    • Handle: RePEc:eee:empfin:v:67:y:2022:i:c:p:60-77
    DOI: 10.1016/j.jempfin.2022.01.003
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    References listed on IDEAS

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    More about this item

    Keywords

    Derivatives; Risk management; Counterparty risk; Credit default swaps; Credit valuation adjustments;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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