Common Risks in the Eurozone

52 Pages Posted: 21 Oct 2014 Last revised: 21 Dec 2015

See all articles by Matthias Held

Matthias Held

WHU - Otto Beisheim School of Management

Marcel Omachel

WHU - Otto Beisheim School of Management

Markus Rudolf

WHU Otto Beisheim Graduate School of Management

Date Written: April 28, 2015

Abstract

We construct a single consistent jump diffusion model with stochastic volatility which incorporates a common Eurozone shock factor to value currency, interest and sovereign debt products in European financial markets. In the model sovereign defaults can be induced either by the common Eurozone shock factor or by country idiosyncratic credit events. The Eurozone shock factor additionally induces a jump in the EUR/USD currency and thus creates a direct codependence between debt and currency markets. We use the model to price Eurozone sovereign CDS contracts and EUR/USD FX options between 2009 and 2014. Our findings suggest that changes in Eurozone shock risk can explain a significant proportion of the variation in EUR/USD volatility skews. The factor also plays an important role in the valuation of Eurozone sovereign CDS contracts. We find further that the Eurozone shock factor as well as idiosyncratic default risks heavily influence FX dynamics, and constitute statistically and economically significant excess return components. We further find a positive market price of (common) Eurozone shock risk.

Keywords: Currency risk, sovereign default risk, Bayesian analysis

Suggested Citation

Held, Matthias and Omachel, Marcel and Rudolf, Markus, Common Risks in the Eurozone (April 28, 2015). Available at SSRN: https://ssrn.com/abstract=2512198 or http://dx.doi.org/10.2139/ssrn.2512198

Matthias Held

WHU - Otto Beisheim School of Management ( email )

Burgplatz 2
Vallendar, 56179
Germany

Marcel Omachel (Contact Author)

WHU - Otto Beisheim School of Management ( email )

Burgplatz 2
Vallendar, 56179
Germany

Markus Rudolf

WHU Otto Beisheim Graduate School of Management ( email )

Burgplatz 2
Vallendar, 56179
Germany
+49-(0)261-6509-420 (Phone)

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
99
Abstract Views
1,739
rank
328,772
PlumX Metrics