Assessing the predictive ability of sovereign default risk on exchange rate returns: FB3-5/2017-19E-PDF

“Increased sovereign credit risk is often associated with sharp currency movements. Therefore, expectations of the probability of a sovereign default event can convey important information regarding future movements of exchange rates. In this paper, we investigate the possible pass-through of risk in the sovereign debt markets to currency markets by proposing a new risk premium factor for predicting exchange rate returns based on sovereign default risk. We compute it from the term structure at different maturities of sovereign credit default swaps and conduct an out-of-sample forecasting exercise to test whether we can improve upon the benchmark random walk model. Our results show that the inclusion of the default risk factor improves the forecasting accuracy upon the random walk model at short forecasting horizons"--Abstract, p. ii.

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Department/Agency Bank of Canada.
Title Assessing the predictive ability of sovereign default risk on exchange rate returns
Series Title Bank of Canada staff working paper,
Publication Type Series - View Master Record
Language [English]
Format Electronic
Electronic Document

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Note "May 2017."
Date 2017.
Number of Pages ii, 37 p. :
Catalogue Number
  • FB3-5/2017-19E-PDF
Subject Terms Capital markets, Exchange rates, Statistical analysis