The impact of currency movements on asset value correlations

This paper looks at the asset correlation bias resulting from firms’ assets and liabilities being denominated in different currencies. It focuses on the time-variation in the bias and on the dependency of the bias on currency movements. Overall, we find that the asset correlation bias for the average pair of firms in the Dow Jones Industrial Average index is significant. The bias fluctuates widely, however, and it has turned negative for shorter periods. The policy implication of the paper is that by ignoring the exchange rate component when computing portfolio credit risk one may materially underestimate the actual risk.