Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/197944 
Year of Publication: 
2017
Series/Report no.: 
Bank of Canada Staff Working Paper No. 2017-19
Publisher: 
Bank of Canada, Ottawa
Abstract: 
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.
Subjects: 
Exchange rates
Econometric and statistical methods
International financial markets
JEL: 
C22
C52
C53
F31
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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