• Credit Derivatives

    Calculating the Unthinkable: Exchange Rate Effects of a Credit Event

    We use quanto credit default swaps to analyse the impact of a credit event in the euro zone on the Dollar-Euro exchange rate. In the light of the European debt crisis, market participants are willing to pay more for protection against a sovereign credit event, if it is denominated in US-Dollars rather than in Euro, due to the fact that they expect the Euro to depreciate in the wake of the credit event. We use this CDS price difference to calculate the implied exchange rate conditional on a credit event, i.e., a default of a member of the Euro zone. We find that the implied effect is very heterogeneous across the different countries.