Effect of Foreign Exchange Rates on the Default Correlation
Default correlation analysis has an important role in asset pricing and credit risk management. Our proposed default model aims to analyze the default correlation for two international companies. In this analysis, we would like to incorporate existing correlation between the stock indices in different countries and study its effect on the default correlation measure. Moreover, there is evidence in the literature of sensitivity of equity index returns to foreign exchange (FX) rates. We believe that the correlation between volatilities of FX rates of local currencies and the volatility in stock exchange returns volatilities will affect the default correlation for two companies in two different countries. We want to design a robust mathematical model, which ultimately quantifies the effect of foreign exchange on the default correlation.