Discussion Paper Details

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Title: Exchange Rates and Sovereign Risk

Author(s): Pasquale Della Corte, Lucio Sarno, Maik Schmeling and Christian Wagner

Publication Date: April 2021

Keyword(s): CDS spreads, Currency options, currency risk premium, Exchange Rates and sovereign risk

Programme Area(s): Financial Economics and International Macroeconomics and Finance

Abstract: An increase in a country's sovereign risk, as measured by credit default swap spreads, is accompanied by a contemporaneous depreciation of its currency and an increase of its volatility. The relation between currency excess returns and sovereign risk is mainly driven by default expectations (rather than distress risk premia) and exposure to global sovereign risk shocks, and also emerges in a predictive setting for currency risk premia. We show that a sovereign risk factor is priced in the cross-section of currency returns and that it is not subsumed by the carry factor.

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Bibliographic Reference

Della Corte, P, Sarno, L, Schmeling, M and Wagner, C. 2021. 'Exchange Rates and Sovereign Risk'. London, Centre for Economic Policy Research.