Why Sovereign CDS Spreads Cannot Be Converted by Currency Alone
Summary
The document explains why sovereign credit default swap spreads in different currencies cannot be reliably harmonized using only interest rates. In an idealized setting with liquid, efficient markets, one could infer risk-neutral default probabilities using one currency’s rates and translate them using another currency’s rates. Actual markets can depart from that framework, so spreads in different currencies reflect market pricing rather than a simple mechanical conversion.
The currency spread relationship, known as a quanto factor, is described as an observable with its own term structure that can fluctuate with supply and demand. For sovereign and quasi-sovereign protection quoted in local currency, expected currency devaluation in a default can also affect the relative spread. Thus, converting a multi-country dataset into USD requires market information on the relevant currency-specific pricing relationships; the document suggests these may be available from market data sources. It gives no step-by-step data procedure, and its numerical ranges are illustrative rather than universal conversion rules.
Key ideas
- CDS spreads in different currencies cannot be reliably converted using interest rates alone.
- Quanto factors capture market-priced differences between currency-denominated CDS spreads.
- Quanto factors vary over time and across maturities, and can reflect supply and demand.
- Expected devaluation following a sovereign default can make local-currency protection price differently from USD protection.
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Full text
# sovereign credit default swap CDS currency conversion on Refinitiv DataStream # sovereign credit default swap CDS currency conversion on Refinitiv DataStream I have download the sovereign CDS 5y spread mid of the 69 countries with available datasets from the Refinitiv DataStream database. when I apply the currency conversion to all of them, I get an error notification with no data returned. But if I request for the data without currency conversion (just the local currency) I get data returned to me. How do I harmonize the datasets under one currency (USD)? ## Answer by Dimitri Vulis (score 1) https://quant.stackexchange.com/a/80688 CDS quotes cannot be reliably converted from one currency to another using just interest rates. In theory, in perfectly liquid and efficient markets, it would be easy to calculate the risk-free probabilities of default from CDS quotes and one currency's interest rates, then back to CDS quotes using another currency's interest rates, but this isn't exactly how markets really work. In reality, the ratio of CDS spreads in different currencies - the quanto factors - are market observables with term structure, often fluctuate .95-1.05 or more, may be available from Totem and/or Refinitiv, and are driven by supply and demand. E.g. someone is building a CDO denominatee in some currency, trading and moving components single-name CDS protection in this currency, but not moving as much CDS on the same names in other currencies. For sovereigns and quasi-sovereigns CDS protection in local currency, the quanto factors may be as low as .4-.6 because of assumed devaluation upon default. E.g. if Italy or France sovereigns default, then EUR will devalue v USD et al, therefore EUR-denominated CDS protection is cheaper than than USD et al, but you can't guess by how much - rather, you need to see how the market prices it. Similarly, US sovereign CDS protection in USD and in EUR are two different animals.
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