Analyzing Target Redemption Forward Contracts under Levy Process

Abstract

The depreciation of the renminbi (RMB) in the last few years had caused many default events on the leveraged structural products called “Target Redemption Forward” (TRF). Analyzing the components of the TRF, we can find these products are composed of buying and selling exchange options. From the empirical analyses of the returns of the exchange rate of USD/CNY, there exist non-normal, leptokurtic and volatility clustering phenomena. Hence, we use the time-changed NIG-Lévy process to construct the dynamics of the exchange rate. Finally, we apply the Monte Carlo simulation technique to price the TRF and analyze the impacts of the clauses in the term sheet of TRF.