Do credit default swaps predict currency values?

Gaiyan Zhang, Jot Yau and Hung-Gay Fung

Applied Financial Economics, 2010, vol. 20, issue 6, 439-458

Abstract: Using daily data of four currencies (Japanese Yen (JPY), Euro (EUR), British Pound (GBP) and Australian Dollar (AUD)) in terms of the US Dollar (USD), and JPY, USD, GBP and AUD in terms of the EUR from January 2004 to February 2008, we examine the lead-lag relationship between the Credit Default Swap (CDS) market and the currency market. Results indicate significant Granger-causality effects flowing from changes in both the North American investment-grade (IG) and high-yield (HY) CDS indices to changes in the JPY, EUR and AUD exchange rates in terms of the USD for the whole period and during the credit crisis of 2007 to 2008. However, for the four currencies in terms of the EUR, significant Granger-causality of the credit risk is found only in the AUD. Our results indicate that changes in CDS index spreads signal important carry-trade information for some currencies, but not others.

Date: 2010
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DOI: 10.1080/09603100903459774

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