Exchange Rates and Sovereign Risk

Lucio Sarno, Pasquale Della Corte, Maik Schmeling and Christian Wagner

No 16058, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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.

Keywords: Exchange rates; Currency risk premium; Currency options; Sovereign risk; Cds spreads (search for similar items in EconPapers)
JEL-codes: F31 G12 G15 (search for similar items in EconPapers)
Date: 2021-04
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