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Exchange Rates and Sovereign Risk

Author

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  • Pasquale Della Corte

    (Department of Finance, Imperial College London, London SW7 2BX, United Kingdom of Great Britain and Northern Ireland)

  • Lucio Sarno

    (Cambridge Judge Business School, University of Cambridge, Cambridge CB2 1AG, United Kingdom)

  • Maik Schmeling

    (Department of Finance, Goethe University Frankfurt, 60323 Frankfurt, Germany)

  • Christian Wagner

    (Department of Finance, Accounting and Statistics, WU Vienna University of Economics and Business and Vienna Graduate School of Finance (VGSF), 1020 Vienna, Austria)

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.

Suggested Citation

  • Pasquale Della Corte & Lucio Sarno & Maik Schmeling & Christian Wagner, 2022. "Exchange Rates and Sovereign Risk," Management Science, INFORMS, vol. 68(8), pages 5591-5617, August.
    • Handle: RePEc:inm:ormnsc:v:68:y:2022:i:8:p:5591-5617
    DOI: 10.1287/mnsc.2021.4115
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    Cited by:

    1. Geyikçi, Utku Bora & Özyıldırım, Süheyla, 2023. "Deviations from covered interest parity in the emerging markets after the global financial crisis," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 85(C).
    2. Della Corte, Pasquale & Jeanneret, Alexandre & Patelli, Ella D.S., 2023. "A credit-based theory of the currency risk premium," Journal of Financial Economics, Elsevier, vol. 149(3), pages 473-496.

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    More about this item

    Keywords

    exchange rates; currency risk premium; currency options; sovereign risk; CDS spreads;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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