Sovereign credit risk and exchange rates: Evidence from CDS quanto spreads
Authors: Patrick Augustin, Mikhail Chernov and Dongho Song
Publication: Journal of Financial Economics, Forthcoming
Abstract:
Sovereign CDS quanto spreads tell us how financial markets view the interaction between a country鈥檚 likelihood of default and associated currency devaluations (the Twin Ds). A no-arbitrage model applied to the term structure of Eurozone quanto spreads can isolate the Twin Ds and gauge the associated risk premiums. Conditional on the occurrence of default, the true and risk-adjusted 1-week probabilities of devaluation are 42% (2%) and 90% (55%) for the core (periphery) countries. The weekly risk premium for Euro devaluation in case of default for the core (periphery) exceeds the regular currency premium by up to 18 (13) basis points.
Desautels 22
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