Leaving a Mark on the Euro
46 Pages Posted: 1 Mar 2018 Last revised: 30 Apr 2018
Date Written: February 28, 2018
I construct a time-series measure of currency redenomination risk in French and Italian government bonds based on different types of CDS contracts. Older contracts are not triggered by a redenomination into a newly issued French or Italian currency while newer contracts are. The risk of France or Italy leaving the Eurozone has substantial spill-over effects on other Eurozone sovereigns. German Bund yields respond negatively to increases in redenomination risk, indicating that "German" euros are becoming more valuable when the composition of the Eurozone is at risk. Most European sovereign bonds and the euro exchange rate depreciate with French, and appreciate with Italian redenomination risk. This discrepancy is consistent with the interpretation that French redenomination risk represents an existential risk to the Eurozone with subsequent redenominations in other sovereign bonds. In contrast, an Italian redenomination is likely to remain isolated and Italian redenomination risk lowers the yields on other periphery sovereign debt, which serve as substitutes to Italian bonds.
Keywords: Redenomination Risk, Credit Default Swaps, Sovereign Debt, Contagion, Exchange Rates
JEL Classification: E43, E58, F3, F31, F34, G01, G12, G15
Suggested Citation: Suggested Citation