Market Inputs and Judgment in FX Forward and Swap Pricing
Summary
The document outlines a practitioner’s framework for pricing FX forwards and swaps using spot, interest-rate curves for both currencies, and a cross-currency basis curve. The proposed construction uses overnight-indexed swap curves from market instruments and derives short-tenor basis from FX swap points, with longer tenors informed by cross-currency quotes. Month-end effects and other irregularities are explicitly set aside.
The question is how dealers obtain short-end basis inputs when their own quotes help form the market data. The response says pricing ultimately reflects a market maker’s willingness to trade, informed by interbank and large institutional or corporate flows. It characterizes the basis as an implied yield relative to the dollar overnight benchmark in the stated quoting context. This highlights the role of dealer judgment and flow in price formation, but supplies no detailed data sources, calibration procedure, or evidence about a standard industry blend.
Key ideas
- FX forward and swap pricing can be framed with spot, two currency rate curves, and a cross-currency basis.
- The proposed curve construction uses market instruments for rate curves and FX swap points or cross-currency quotes for basis.
- Dealer quotes are partly formed through judgments about acceptable prices and adjustments for customer and interbank flows.
- The document does not establish a universal method for gathering or blending short-tenor pricing inputs.
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Full text
# What XCCY pricing inputs do large market makers use for FX Forwards/Swaps? # What XCCY pricing inputs do large market makers use for FX Forwards/Swaps? While there are a few similar questions on here regarding FXF pricing, I was unable to find something that answers this directly. To be more specific, it's clear that as per CIP, the pricing inputs for an FX swap are: - Spot rate $S_t$ - Interest rate for the base (domestic) currency $r_d$ - Interest rate for the quoted (foreign) currency $r_f$ - Cross currency basis $z$ As an amateur practitioner, I would construct an OIS curve for $r_d$, $r_f$ using quotes from market instruments (futures, IRS)*. Subsequently, I would strip out a cross currency basis ($z$) curve, using market observable FX swap points as my primary input for tenors up to 2-3Y, after which observed XCCY quotes take over. With these three curves, as well as a spot rate, I should be able to reprice FX forwards to market for any date on the curve (forgetting for a moment about month-end turns and other idiosyncratic points). This is where I run into a conceptual gap--I assume that price makers cannot use electronic FX swap quotes as inputs for market observed cross currency basis in the short end, since they are effectively the ones pricing them. Are they using quotes from voice brokerage? FX futures exchanges? a proprietary blend? ## Answer by river_rat (score 2) https://quant.stackexchange.com/a/79580 To be blunt, we make them up - generally as an implied yield over sofr if usd is the main base currency quote. This is fundamentally true for almost every derivative price, at some level the price comes from where some person thinks it should be. The machinery for creating that price may be different, SABR parameters or ATM vols and RR quotes but some person has to decide where they are prepared to pay or receive 3 month FX rates or vol etc and adjust those prices given interbank and large corporate / NBFI flows.
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