Private Information in Currency Markets

Abstract

Using daily abnormal currency returns for the universe of countries with flexible exchange rates, we document local currency depreciations ahead of unscheduled, public, sovereign debt downgrade announcements. Consistent with the private information hypothesis, the effect is stronger in lower institutional quality countries and holds after we control for concurrent public information and for publically available rumors about the forthcoming downgrades. Our results persist when abnormal currency returns are adjusted for global carry and dollar risk factors, world equity and bond returns as well as local stock market returns. Finally, the currency depreciations are permanent, providing evidence for a link between fundamentals and currency markets.

Keywords: sovereign debt ratings, foreign exchange, institutional quality, information leakage, TRMI

JEL Classification: G14, G15, G24