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

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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)

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    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.

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    Bibliographic Info

    Paper provided by Hong Kong Institute for Monetary Research in its series Working Papers with number 252010.

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    Length: 33 pages
    Date of creation: Oct 2010
    Date of revision:
    Handle: RePEc:hkm:wpaper:252010

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    Keywords: European Sovereign Debt Crisis; Currency Options; Credit Default Swaps; Currency Crash;

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    1. Charles Quanwei Cao & Gurdip S. Bakshi & Zhiwu Chen, 1997. "Empirical Performance of Alternative Option Pricing Models," Yale School of Management Working Papers ysm65, Yale School of Management.
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    13. Bates, David S, 1991. " The Crash of '87: Was It Expected? The Evidence from Options Markets," Journal of Finance, American Finance Association, vol. 46(3), pages 1009-44, July.
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