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Euro at Risk: The Impact of Member Countries’ Credit Risk on the Stability of the Common Currency

Lamia Bekkour (), Xisong Jin (), Thorsten Lehnert, Fanou Rasmouki and Christian Wolff

No 9229, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: In this paper, we empirically investigate the impact of the credit risk of Eurozone member countries on the stability of the Euro. In the absence of a common euro bond, euro-area credit risk is induced though the credit default swaps of the member countries. The stability of the euro is examined by decomposing dollar-euro exchange rate options into the moments of the risk-neutral distribution. We document that during the sovereign debt crisis changes in the creditworthiness of member countries have significant impact on the stability of the euro. In particular, an increase in member countries’ credit risk results in an increase of volatility of the dollar-euro exchange rate along with soaring tail risk induced through the risk-neutral kurtosis. We find that member countries’ credit risk is a major determinant of the euro crash risk as measured by the risk-neutral skewness. We propose a new indicator for currency stability by combining the risk-neutral moments into an aggregated risk measure and show that our results are robust to this change in measure. Noticeable is the fact that during the sovereign debt crisis, the creditworthiness of countries with vulnerable fiscal positions is the main risk-endangering factor of the euro-stability.

Keywords: credit default swaps; currency options; currency stability; European sovereign debt crisis; risk-neutral distribution (search for similar items in EconPapers)
JEL-codes: G1 (search for similar items in EconPapers)
Date: 2012-11
New Economics Papers: this item is included in nep-eec, nep-mon, nep-opm and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
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Related works:
Journal Article: Euro at risk: The impact of member countries' credit risk on the stability of the common currency (2015) Downloads
Working Paper: Euro at Risk: The Impact of Member Countries Credit Risk on the Stability of the Common Currency (2012) Downloads
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