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oislah
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Are basis spreads toxic?

November 21st, 2016, 11:08 pm

Maybe a naive question: do basis spreads depend to some extent (I want to think to a large extent) on volatility surfaces ? Is the way forward to manage this kind of risk via basis spreads vegas? Are the hedges stable for some economic reason ?
Thanks for enlightening me
 
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Martinghoul
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Re: Are basis spreads toxic?

November 22nd, 2016, 10:40 am

No, this wouldn't make a lot of sense, IMHO...
 
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oislah
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Re: Are basis spreads toxic?

November 22nd, 2016, 11:14 am

Cross currency basis spreads appeared ( or were more pronounced late 90s early 2000s ) in the context of the USD/Jpy carry trade
Probably as a result of an equilibrium between Japanese investors averse to currency risk and who just bought FX options or PRSCs and those "risk neutral " who just swapped the currency
is the basis spreads not an equilibrium cost of hedging between options and swaps?
 
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Martinghoul
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Re: Are basis spreads toxic?

November 22nd, 2016, 1:58 pm

Well, to some extent all these things are connected, indeed...  You could argue that some common factors (e.g. banking system stress, etc) are responsible for movements in both, but it's a pretty large leap of faith from that to accurate hedging.

And no, I can't imagine how basis can be thought of as the "cost of hedging between options and swaps".  I am not even sure what the latter means exactly.
 
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oislah
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Re: Are basis spreads toxic?

November 22nd, 2016, 2:33 pm

I don't know either what it means, it is just my 2 pennies on a potential economic rationale given that if I am EURO investor and I want to buy say some bonds/Shares in the US that would yield say 5-6%
Either I hedge with a rolling spot FX or CCBS and in this case the cost of hedging would be Dom rates-foreign rates-CCBS...and this would be quite expensive..or I can hedge using an FX Option at strike=spot
I know this is not a replication argument but here we would need an economic model says with different agents ( investors, hedgers, fund raisers both EUR and USD based) and this is pure speculation I believe it will lead to
a functional formula of the type
CCBS=f(Fx vol, Fx forward, Maturity, other parameters)
Other parameters would characterise the economy
 
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Martinghoul
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Re: Are basis spreads toxic?

November 22nd, 2016, 5:22 pm

Ah, so you're talking about x-ccy basis here?
 
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oislah
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Re: Are basis spreads toxic?

November 22nd, 2016, 8:54 pm

Indeed I am talking just about X-Ccy basis that I call CCBS
 
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Martinghoul
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Re: Are basis spreads toxic?

November 23rd, 2016, 9:31 am

That's a tough and complicated one and there's a LOT of recent discussions of everything that's going on in these mkts.
 
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mtsm
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Re: Are basis spreads toxic?

November 23rd, 2016, 4:02 pm

I think you might be surprised to find out how little options have to do with vol surfaces...
 
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oislah
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Re: Are basis spreads toxic?

November 23rd, 2016, 4:05 pm

Can you elaborate?