Currency Total Return Swaps: Valuation and Risk Factor Analysis∗

providing us with CTRS data, and Laurent Bodson for excellent research assistance. Financial supports from SSHRC (François) and Deloitte Luxemburg (Hübner) are gratefully acknowledged. All remaining errors are ours. 1 Currency Total Return Swaps: Valuation and Risk Factor Analysis Currency total return swaps (CTRS) are hybrid derivatives instruments that allow to simultaneously hedge against credit and currency risks. We develop a structural credit risk model to evaluate CTRS premia. Empirical test on a sample of 23,005 price observations from 59 underlying issuers yields an average percentage error of around 10%. This indicates that, beyond interest rate risk, firm-specific factors are major drivers of the variations in the valuation of these instruments. Regression analysis of residuals shows that exchange rate determinants account for up to 40 % of model pricing errors — indicating that a currency risk premium affects the CTRS price significantly but only marginally, which confirms the prevalence of credit risk in the pricing of CTRS