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The term structure of sovereign credit default swap and the cross‐section of exchange rate predictability
Author(s) -
Calice Giovanni,
Zeng Ming
Publication year - 2021
Publication title -
international journal of finance and economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.505
H-Index - 39
eISSN - 1099-1158
pISSN - 1076-9307
DOI - 10.1002/ijfe.1798
Subject(s) - credit default swap , sovereign credit , predictability , economics , risk premium , monetary economics , currency , credit risk , exchange rate , credit default swap index , sovereign default , stock (firearms) , financial economics , sovereignty , finance , credit valuation adjustment , physics , quantum mechanics , sovereign debt , politics , political science , law , mechanical engineering , credit reference , engineering
We provide novel evidence on exchange rate predictability by using the term premia of the sovereign credit default swap (CDS). Using a sample of 29 countries, we find that the sovereign CDS term premia significantly predict the exchange rates out‐of‐sample. On average, a steeper CDS spread curve for a country predicts its currency appreciation against the U.S. dollar (USD). Empirically, although the sovereign CDS level mainly reflects global risk, the information in the term premia of the sovereign CDS spreads reveals country‐specific risk. Notably, the predictive power of the term premia is robust after controlling for the sovereign CDS level and other conventional global macroeconomic and financial factors. Further analysis shows that the information in the sovereign CDS term premia is also helpful for forecasting international stock market returns.