Sovereign Credit and Exchange Rate Risks: Evidence from Asia-Pacific Local Currency Bonds

Chernov, Mikhail; Creal, Drew; Hördahl, Peter

doi:10.3386/w27500

Cited by 5 publications

(1 citation statement)

References 40 publications

(25 reference statements)

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“…In particular, emerging currencies reflect credit risk of the respective sovereigns, and thus, the economic composition of the associated currency risk premiums is different (see, e.g., Na et al. (2018), Chernov, Creal, and Hördahl (2020)).…”

Section: Evidencementioning

confidence: 99%

Pricing Currency Risks

Chernov¹,

Dahlquist²,

Lochstoer³

2022

The Journal of Finance

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The currency market features a small cross-section, and conditional expected returns can be characterized by few signals: interest differential, trend, and mean reversion. We exploit these properties to construct the ex ante mean-variance efficient portfolio of individual currencies. The portfolio is updated in real time and prices all prominent currency trading strategies, conditionally and unconditionally. The fraction of risk in these assets that does not affect their risk premiums is at least 85%. Extant explanations of carry strategies based on intermediary capital or global volatility are related to these unpriced components, while consumption growth is related to the priced component of returns.

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Section: Evidencementioning

confidence: 99%

Pricing Currency Risks

Chernov¹,

Dahlquist²,

Lochstoer³

2022

The Journal of Finance

Self Cite

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Sovereign default network and currency risk premia

Yang

Yang²,

Cui

2023

Financ Innov

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We construct a sovereign default network by employing high-dimensional vector autoregressions obtained by analyzing connectedness in sovereign credit default swap markets. We develop four measures of centrality, namely, degree, betweenness, closeness, and eigenvector centralities, to detect whether network properties drive the currency risk premia. We observe that closeness and betweenness centralities can negatively drive currency excess returns but do not exhibit a relationship with forward spread. Thus, our developed network centralities are independent of an unconditional carry trade risk factor. Based on our findings, we develop a trading strategy by taking a long position on peripheral countries’ currencies and a short position on core countries’ currencies. The aforementioned strategy generates a higher Sharpe ratio than the currency momentum strategy. Our proposed strategy is robust to foreign exchange regimes and the coronavirus disease 2019 pandemic.

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