Do Credit Default Swaps Predict Currency Values?

44 Pages Posted: 1 Nov 2009

See all articles by Gaiyan Zhang

Gaiyan Zhang

University of Missouri at St. Louis - College of Business Administration

Jot Yau

Seattle University

Hung-Gay Fung

University of Missouri at Saint Louis - College of Business Administration

Date Written: October 20, 2009

Abstract

Using daily data of four currencies (Japanese yen, euro, British pound, and Australian dollar) in terms of the U.S. dollar, and these four currencies in terms of the euro 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 Japanese yen, euro, and Australian dollar exchange rates in terms of the U.S. dollar for the whole period and during the credit crisis of 2007-2008. However, for the four currencies in terms of the euro, significant Granger-causality of the credit risk, measured by iTraxx Europe, is found only for the Australian dollar. Our results indicate that changes in CDS index spreads signal important carry trade information for some currencies, but not others.

Keywords: Credit default Swaps, foreign exchange rates, lead-lag relationship, carry trade

JEL Classification: C22, G14, G15, F31

Suggested Citation

Zhang, Gaiyan and Yau, Jot and Fung, Hung-Gay, Do Credit Default Swaps Predict Currency Values? (October 20, 2009). Applied Financial Economics, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1497584

Gaiyan Zhang (Contact Author)

University of Missouri at St. Louis - College of Business Administration ( email )

One University Blvd
St. Louis, MO 63121
United States

Jot Yau

Seattle University ( email )

901 12th Avenue
Seattle, WA 98122
United States

Hung-Gay Fung

University of Missouri at Saint Louis - College of Business Administration ( email )

One University Blvd.
487 SSB
St. Louis, MO 63121
United States
314-516-6374 (Phone)

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