Managing Unhedgeable Rate-FX Cross Gamma in Callable PRDC Notes

Summary

The post asks how to hedge the cross gamma between interest rates and foreign exchange in a callable power reverse dual currency note. The brief answer is that this exposure may be difficult or impossible to hedge because the market has too few counterparties willing to supply the needed instruments.

As a practical consequence, dealers may have to retain the residual risk. If many dealers hold similar exposures, their hedging or valuation sensitivities can be concentrated in the same relationship, potentially strengthening the observed correlation between US swap rates and USD/JPY. The post gives no hedge construction, pricing analysis, or empirical evidence, and its conclusion is a short market observation rather than a general quantitative treatment. Its usefulness is chiefly as a reminder that complex cross risks can remain unhedged when suitable risk-transfer capacity is scarce.

Key ideas

• Callable PRDC notes can expose dealers to cross gamma between rates and foreign exchange.
• The answer says limited supplier capacity can make this exposure difficult to hedge.
• Dealers may retain the risk when no adequate hedge is available.
• Concentrated dealer exposures may contribute to a high correlation between US swap rates and USD/JPY.

Tags

# How to hedge x gamma in callable prdc?


# How to hedge x gamma in callable prdc?












How do you hedge the short rates - fx cross gamma in a callable PRDC (Power Reverse Dual Currency note) ?

## Answer by dm63 (score 3)

https://quant.stackexchange.com/a/45195

You generally can’t. There aren’t enough suppliers. Therefore you end up living with it , which means that the correlation between US swap rates and USDJPY Fx can get very high since many dealers have it.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.