A Credit-Based Theory of the Currency Risk Premium

117 Pages Posted: 3 Jul 2019 Last revised: 16 Aug 2021

See all articles by Pasquale Della Corte

Pasquale Della Corte

Imperial College Business School; Centre for Economic Policy Research (CEPR)

Alexandre Jeanneret

UNSW Business School

Ella Patelli

UBC - Sauder School of Business

Date Written: August 8, 2021

Abstract

This paper extends Kremens and Martin (2019) and uncovers a novel component for exchange rate predictability based on the price difference between sovereign credit default swaps denominated in different currencies. This new forecasting variable - the credit-implied risk premium - captures the expected currency depreciation conditional on a severe but rare credit event. Using data for 16 Eurozone countries, we find that the credit-implied risk premium positively forecasts the dollar-euro exchange rate return at various horizons. Moreover, a currency strategy that exploits the informative content of our predictor generates substantial out-of-sample economic value against the naive random walk benchmark.

Keywords: exchange rate, predictability, risk premium, credit risk, sovereign default

JEL Classification: F31, F37, F47, G12, G15

Suggested Citation

Della Corte, Pasquale and Jeanneret, Alexandre and Patelli, Ella, A Credit-Based Theory of the Currency Risk Premium (August 8, 2021). Available at SSRN: https://ssrn.com/abstract=3413785 or http://dx.doi.org/10.2139/ssrn.3413785

Pasquale Della Corte

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London, SW7 2AZ
United Kingdom
+44(0)20 759 49331 (Phone)

HOME PAGE: http://sites.google.com/view/pasqualedellacorte

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Alexandre Jeanneret (Contact Author)

UNSW Business School ( email )

Sydney, NSW 2052
Australia

Ella Patelli

UBC - Sauder School of Business ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
639
Abstract Views
2,522
Rank
72,821
PlumX Metrics