The Risk of Sudden Depreciation of the Euro in the Sovereign Debt Crisis of 2009-2010

Cho-Hoi Hui and Tsz-Kin Chung
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Cho-Hoi Hui: Hong Kong Monetary Authority and Hong Kong Institute for Monetary Research
Tsz-Kin Chung: Hong Kong Monetary Authority

No 252010, Working Papers from Hong Kong Institute for Monetary Research

Abstract: The economic-political instability of a country, which is tied to its credit risk, often leads to sharp depreciation and heightened volatility in its currency. This paper shows that not only the creditworthiness of the euro-area countries with weaker fiscal positions but also that of the member countries with more sound fiscal positions are important determinants of the deep out-of-the-money euro put option prices, which embedded information on the euro crash risk during the sovereign debt crisis of 2009-2010. Using information on the option prices under the stochastic-volatility jump-diffusion model, the euro's crash probability of 11% in a year with crash size of 14% is estimated at the end of April 2010. However, during the period of the global financial crisis between the Lehman default and September 2009 before the debt crisis began, the estimated crash size reflects the potential sharp devaluation of the US dollar that might result from quantitative easing in the US.

Keywords: European Sovereign Debt Crisis; Currency Options; Credit Default Swaps; Currency Crash (search for similar items in EconPapers)
JEL-codes: F31 G13 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2010-10
New Economics Papers: this item is included in nep-cba, nep-eec and nep-ifn
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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