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

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Listed:
  • Cho-Hoi Hui

    (Hong Kong Monetary Authority and Hong Kong Institute for Monetary Research)

  • Tsz-Kin Chung

    (Hong Kong Monetary Authority)

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.

Suggested Citation

  • Cho-Hoi Hui & Tsz-Kin Chung, 2010. "The Risk of Sudden Depreciation of the Euro in the Sovereign Debt Crisis of 2009-2010," Working Papers 252010, Hong Kong Institute for Monetary Research.
  • Handle: RePEc:hkm:wpaper:252010
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    References listed on IDEAS

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    Cited by:

    1. Michael Bleaney & Veronica Veleanu, 2017. "Currency risk in corporate bond spreads in the eurozone," Discussion Papers 2017/07, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).

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    More about this item

    Keywords

    European Sovereign Debt Crisis; Currency Options; Credit Default Swaps; Currency Crash;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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