Currency dependence of corporate credit spreads

Many pricing and risk management models need credit spread curves as an input. Given the small number of bonds outstanding per issuer the estimation of credit spread curves is not trivial in the corporate bond market. To ensure a sufficient number of bonds for the estimation procedure in many cases bonds in different currencies have to be used which implies that the estimation procedure has to take into account potential currency effects. Using a rather general pricing framework we show that credit spreads for a certain issuer are expected to be equal across different currencies only if the correlation between the default variables and the exchange rates deflated by the relevant money market account is zero. This paper presents a new model which allows to estimate a credit spread curve for a single issuer with bonds in different currencies and simultaneously allows for testing for the existence of currency related effects. This new model is based on the multi-curve estimation approach which allows a parsimonious joint estimation of a risk free term structure and the credit spread curve of the issuer. We reject the hypothesis of zero correlation between credit and exchange rate risk and present empirical evidence that there are significant differences of issuer specific credit spreads across different currencies in a representative sample of international corporate bonds. Moreover, this implies that dollar related credit spread curves cannot be used without special care for pricing defaultable claims denominated in other currencies. JEL: G12, G13, G15; C13