Benjamin C. Esty, William L. Megginson, Creditor Rights, Enforcement, and Debt Ownership Structure: Evidence from the Global Syndicated Loan Market, The Journal of Financial and Quantitative Analysis, Vol. 38, No. 1 (Mar., 2003), pp. 37-59

This paper develops an expected utility model of a multinational firm facing exchange rate risk exposure to a foreign currency cash flow. Currency derivative markets do not exist between the domestic and foreign currencies. There are, however, currency futures and options markets between the domestic currency and a third currency to which the firm has access. Since a triangular parity condition holds among these three currencies, the available, yet incomplete, currency futures and options markets still provide a useful avenue for the firm to indirectly hedge against its foreign exchange risk exposure. This paper offers analytical insights into the optimal cross-hedging strategies of the firm. In particular, the results show the optimality of using options in conjunction with futures in the case of currency mismatching, even though cash flows appear to be linear.

Enrico C. Perotti, Ernst-Ludwig von Thadden, Strategic Transparency and Informed Trading: Will Capital Market Integration Force Convergence of Corporate Governance?, The Journal of Financial and Quantitative Analysis, Vol. 38, No. 1 (Mar., 2003), pp. 61-85

We propose a multifactor model in which the spot rate, LIBOR, follows a lognormal process, with a stochastic conditional mean, under the risk-neutral measure. In addition to the spot rate factor, the second factor is related to the premium of the first futures rate over the spot LIBOR. Similarly, the third factor is related to the premium of the second futures rate over the first futures rate. We calibrate the model to the initial term structure of futures rates and to the implied volatilities of interest rate caplets. We then apply the model to price interest rate derivatives such as European- and Bermudan-style swaptions, and yieldspread options. The model can be employed to price more complex interest rate derivatives such as path-dependent derivatives or multi-currency-dependent derivatives because of its Markovian property.