IDEAS home Printed from https://ideas.repec.org/a/eee/empfin/v33y2015icp67-83.html
   My bibliography  Save this article

Euro at risk: The impact of member countries' credit risk on the stability of the common currency

Author

Listed:
  • Bekkour, Lamia
  • Jin, Xisong
  • Lehnert, Thorsten
  • Rasmouki, Fanou
  • Wolff, Christian

Abstract

In this paper, we propose a new indicator of Euro stability. We make use of this new indicator and empirically investigate the impact of changes in sovereign risk of Eurozone member countries on the stability of the Euro. The stability of the Euro is proxied by decomposing Dollar–Euro exchange rate options into the moments of the risk-neutral distribution. Our stability measure can nicely separate periods of Dollar instability (the subprime crisis period) and Euro instability (the sovereign debt crisis period). In particular, we document that only during the sovereign debt crisis, changes in the creditworthiness of member countries with vulnerable fiscal positions have a significant impact on the stability of the common currency. Interestingly, however, the market perceives Greece not to be ‘systemically relevant’.

Suggested Citation

  • Bekkour, Lamia & Jin, Xisong & Lehnert, Thorsten & Rasmouki, Fanou & Wolff, Christian, 2015. "Euro at risk: The impact of member countries' credit risk on the stability of the common currency," Journal of Empirical Finance, Elsevier, vol. 33(C), pages 67-83.
    • Handle: RePEc:eee:empfin:v:33:y:2015:i:c:p:67-83
    DOI: 10.1016/j.jempfin.2015.06.004
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0927539815000675
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.jempfin.2015.06.004?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to look for a different version below or search for a different version of it.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Bertrand Candelon & Mr. Amadou N Sy & Mr. Rabah Arezki, 2011. "Sovereign Rating News and Financial Markets Spillovers: Evidence from the European Debt Crisis," IMF Working Papers 2011/068, International Monetary Fund.
    2. Graciela Kaminsky & Saul Lizondo & Carmen M. Reinhart, 1998. "Leading Indicators of Currency Crises," IMF Staff Papers, Palgrave Macmillan, vol. 45(1), pages 1-48, March.
    3. Gabaix, Xavier & Verdelhan, Adrien & Rancière, Romain & Farhi, Emmanuel & Fraiberger, Samuel P., 2009. "Crash Risk in Currency Markets," CEPR Discussion Papers 7322, C.E.P.R. Discussion Papers.
    4. Craig Burnside & Martin Eichenbaum & Isaac Kleshchelski & Sergio Rebelo, 2011. "Do Peso Problems Explain the Returns to the Carry Trade?," The Review of Financial Studies, Society for Financial Studies, vol. 24(3), pages 853-891.
    5. Christoffersen, Peter & Heston, Steven & Jacobs, Kris, 2010. "Option Anomalies and the Pricing Kernel," Working Papers 11-17, University of Pennsylvania, Wharton School, Weiss Center.
    6. Frankel, Jeffrey A & Rose, Andrew K, 1996. "Currency Crashes in Emerging Markets: Empirical Indicators," CEPR Discussion Papers 1349, C.E.P.R. Discussion Papers.
    7. Neumann, Michael & Skiadopoulos, George, 2013. "Predictable Dynamics in Higher-Order Risk-Neutral Moments: Evidence from the S&P 500 Options," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 48(3), pages 947-977, June.
    8. Wolff, Christian C, 1987. "Forward Exchange Rates and Expected Future Spot Rates," CEPR Discussion Papers 187, C.E.P.R. Discussion Papers.
    9. Nicolae Garleanu & Lasse Heje Pedersen & Allen M. Poteshman, 2009. "Demand-Based Option Pricing," The Review of Financial Studies, Society for Financial Studies, vol. 22(10), pages 4259-4299, October.
    10. Wolff, Christian C P, 1987. "Forward Foreign Exchange Rates, Expected Spot Rates, and Premia: A Signal-Extraction Approach," Journal of Finance, American Finance Association, vol. 42(2), pages 395-406, June.
    11. Afonso, António & Furceri, Davide & Gomes, Pedro, 2012. "Sovereign credit ratings and financial markets linkages: Application to European data," Journal of International Money and Finance, Elsevier, vol. 31(3), pages 606-638.
    12. Jun Pan & Kenneth J. Singleton, 2008. "Default and Recovery Implicit in the Term Structure of Sovereign CDS Spreads," Journal of Finance, American Finance Association, vol. 63(5), pages 2345-2384, October.
    13. Acharya, Viral V. & Johnson, Timothy C., 2007. "Insider trading in credit derivatives," Journal of Financial Economics, Elsevier, vol. 84(1), pages 110-141, April.
    14. Frankel, Jeffrey A. & Rose, Andrew K., 1996. "Currency crashes in emerging markets: An empirical treatment," Journal of International Economics, Elsevier, vol. 41(3-4), pages 351-366, November.
    15. Markus K. Brunnermeier & Stefan Nagel & Lasse H. Pedersen, 2009. "Carry Trades and Currency Crashes," NBER Chapters, in: NBER Macroeconomics Annual 2008, Volume 23, pages 313-347, National Bureau of Economic Research, Inc.
    16. Gurdip Bakshi & Nikunj Kapadia & Dilip Madan, 2003. "Stock Return Characteristics, Skew Laws, and the Differential Pricing of Individual Equity Options," The Review of Financial Studies, Society for Financial Studies, vol. 16(1), pages 101-143.
    17. Dennis Bams & Thorsten Lehnert & Christian C. P. Wolff, 2009. "Loss Functions in Option Valuation: A Framework for Selection," Management Science, INFORMS, vol. 55(5), pages 853-862, May.
    18. repec:bla:jfinan:v:53:y:1998:i:6:p:2059-2106 is not listed on IDEAS
    19. Hui, Cho-Hoi & Chung, Tsz-Kin, 2011. "Crash risk of the euro in the sovereign debt crisis of 2009-2010," Journal of Banking & Finance, Elsevier, vol. 35(11), pages 2945-2955, November.
    20. Carr, Peter & Wu, Liuren, 2007. "Theory and evidence on the dynamic interactions between sovereign credit default swaps and currency options," Journal of Banking & Finance, Elsevier, vol. 31(8), pages 2383-2403, August.
    21. Cho-Hoi Hui & Tom Fong, 2011. "Information Flow between Sovereign CDS and Dollar-Yen Currency Option Markets in the Sovereign Debt Crisis of 2009-2011," Working Papers 402011, Hong Kong Institute for Monetary Research.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Lin, Yuehao & Lehnert, Thorsten & Wolff, Christian, 2019. "Skewness risk premium: Theory and empirical evidence," International Review of Financial Analysis, Elsevier, vol. 63(C), pages 174-185.
    2. Yunus AÇCI & Selim KAYHAN & Tayfur BAYAT, 2018. "The effect of credit default swap premiums on developing markets’ economies: The case of exchange rates," Theoretical and Applied Economics, Asociatia Generala a Economistilor din Romania / Editura Economica, vol. 0(4(617), W), pages 235-252, Winter.
    3. Kräussl, Roman & Lehnert, Thorsten & Senulytė, Sigita, 2016. "Euro crash risk," Journal of Empirical Finance, Elsevier, vol. 38(PA), pages 417-428.
    4. Kräussl, Roman & Lehnert, Thorsten & Stefanova, Denitsa, 2016. "The European sovereign debt crisis: What have we learned?," Journal of Empirical Finance, Elsevier, vol. 38(PA), pages 363-373.
    5. Thorsten Lehnert & Yuehao Lin & Nicolas Martelin, 2013. "Stein s Overreaction Puzzle: Option Anomaly or Perfectly Rational Behavior?," LSF Research Working Paper Series 13-11, Luxembourg School of Finance, University of Luxembourg.
    6. Muhsin Kar & Tayfur Bayat & Selim Kayhan, 2016. "Impacts of Credit Default Swaps on Volatility of the Exchange Rate in Turkey: The Case of Euro," IJFS, MDPI, vol. 4(3), pages 1-18, July.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Hui, Cho-Hoi & Fong, Tom Pak-Wing, 2015. "Price cointegration between sovereign CDS and currency option markets in the financial crises of 2007–2013," International Review of Economics & Finance, Elsevier, vol. 40(C), pages 174-190.
    2. Cho-Hoi Hui & Chi-Fai Lo & Po-Hon Chau, 2016. "Exchange Rate Dynamics and US Dollar-denominated Sovereign Bond Prices in Emerging Markets," Working Papers 072016, Hong Kong Institute for Monetary Research.
    3. Ivelina Pavlova & Maria E. de Boyrie, 2015. "Carry Trades and Sovereign CDS Spreads: Evidence from Asia‐Pacific Markets," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 35(11), pages 1067-1087, November.
    4. Hui, Cho-Hoi & Lo, Chi-Fai & Chau, Po-Hon, 2018. "Exchange rate dynamics and US dollar-denominated sovereign bond prices in emerging markets," The North American Journal of Economics and Finance, Elsevier, vol. 44(C), pages 109-128.
    5. Augustin, Patrick & Subrahmanyam, Marti G. & Tang, Dragon Yongjun & Wang, Sarah Qian, 2014. "Credit Default Swaps: A Survey," Foundations and Trends(R) in Finance, now publishers, vol. 9(1-2), pages 1-196, December.
    6. Hui, Cho-Hoi & Chung, Tsz-Kin, 2011. "Crash risk of the euro in the sovereign debt crisis of 2009-2010," Journal of Banking & Finance, Elsevier, vol. 35(11), pages 2945-2955, November.
    7. Hui, Cho-Hoi & Lo, Chi-Fai & Chau, Po-Hon & Wong, Andrew, 2020. "Does Bitcoin behave as a currency?: A standard monetary model approach," International Review of Financial Analysis, Elsevier, vol. 70(C).
    8. Hui, Cho-Hoi & Lo, Chi-Fai & Liu, Chi-Hei, 2022. "Exchange rate dynamics with crash risk and interventions," International Review of Economics & Finance, Elsevier, vol. 79(C), pages 18-37.
    9. Cho-Hoi Hui & Tsz-Kin Chung, 2010. "The Risk of Sudden Depreciation of the Euro in the Sovereign Debt Crisis of 2009-2010," Working Papers 252010, Hong Kong Institute for Monetary Research.
    10. Cho-Hoi Hui & Tom Fong, 2011. "Information Flow between Sovereign CDS and Dollar-Yen Currency Option Markets in the Sovereign Debt Crisis of 2009-2011," Working Papers 402011, Hong Kong Institute for Monetary Research.
    11. Du, Du, 2013. "General equilibrium pricing of currency and currency options," Journal of Financial Economics, Elsevier, vol. 110(3), pages 730-751.
    12. Cho-Hoi Hui & Edward Tan, 2016. "Dynamic interactions between government bonds and exchange rate expectations in currency options," Working Papers 182016, Hong Kong Institute for Monetary Research.
    13. De Santis, Roberto A., 2015. "A measure of redenomination risk," Working Paper Series 1785, European Central Bank.
    14. Rövekamp, Ingmar & Eichler, Stefan, 2016. "A market-based indicator of currency risk: Evidence from American Depositary Receipts," VfS Annual Conference 2016 (Augsburg): Demographic Change 145791, Verein für Socialpolitik / German Economic Association.
    15. Della Corte, Pasquale & Sarno, Lucio & Tsiakas, Ilias, 2011. "Spot and forward volatility in foreign exchange," Journal of Financial Economics, Elsevier, vol. 100(3), pages 496-513, June.
    16. Roberto A. De Santis, 2019. "Redenomination Risk," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 51(8), pages 2173-2206, December.
    17. Pu, Xiaoling & Zhang, Jianing, 2012. "Can dual-currency sovereign CDS predict exchange rate returns?," Finance Research Letters, Elsevier, vol. 9(3), pages 157-166.
    18. J. Alsubaiei, Bader & Calice, Giovanni & Vivian, Andrew, 2021. "Sovereign CDS and mutual funds: Global evidence," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 73(C).
    19. Eichler, Stefan & Roevekamp, Ingmar, 2018. "A market-based measure for currency risk in managed exchange rate regimes," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 57(C), pages 141-159.
    20. Ahmed, Jameel & Straetmans, Stefan, 2015. "Predicting exchange rate cycles utilizing risk factors," Journal of Empirical Finance, Elsevier, vol. 34(C), pages 112-130.

    More about this item

    Keywords

    European sovereign debt crisis; Currency options; Credit default swaps; Currency stability; Crash risk; Sovereign capital structure arbitrage;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • F31 - International Economics - - International Finance - - - Foreign Exchange

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:empfin:v:33:y:2015:i:c:p:67-83. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/jempfin .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.