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Do credit default swaps predict currency values?

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  • Gaiyan Zhang
  • Jot Yau
  • Hung-Gay Fung

Abstract

Using daily data of four currencies (Japanese Yen (JPY), Euro (EUR), British Pound (GBP) and Australian Dollar (AUD)) in terms of the US Dollar (USD), and JPY, USD, GBP and AUD in terms of the EUR from January 2004 to February 2008, we examine the lead-lag relationship between the Credit Default Swap (CDS) market and the currency market. Results indicate significant Granger-causality effects flowing from changes in both the North American investment-grade (IG) and high-yield (HY) CDS indices to changes in the JPY, EUR and AUD exchange rates in terms of the USD for the whole period and during the credit crisis of 2007 to 2008. However, for the four currencies in terms of the EUR, significant Granger-causality of the credit risk is found only in the AUD. Our results indicate that changes in CDS index spreads signal important carry-trade information for some currencies, but not others.

Suggested Citation

  • Gaiyan Zhang & Jot Yau & Hung-Gay Fung, 2010. "Do credit default swaps predict currency values?," Applied Financial Economics, Taylor & Francis Journals, vol. 20(6), pages 439-458.
  • Handle: RePEc:taf:apfiec:v:20:y:2010:i:6:p:439-458 DOI: 10.1080/09603100903459774
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    Cited by:

    1. Romain Cuchet & Pascal François & Georges Hübner, 2013. "Currency total return swaps: valuation and risk factor analysis," Quantitative Finance, Taylor & Francis Journals, vol. 13(7), pages 1135-1148, February.
    2. Fung, Hung-Gay & Tse, Yiuman & Zhao, Lin, 2013. "Are stock markets in Asia related to carry trade?," Pacific-Basin Finance Journal, Elsevier, vol. 25(C), pages 200-216.
    3. Tse, Yiuman & Wald, John K., 2013. "Insured uncovered interest parity," Finance Research Letters, Elsevier, vol. 10(4), pages 175-183.

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