Exchange rates, foreign currency exposure and sovereign risk

Arbeitspapier

We quantify the causal link between exchange rate movements and sovereign risk of 16 major emerging market economies (EMEs) by means of structural vector autoregressive models (SVARs) using data from 10/2004 through 12/2016. We apply a novel data based identification approach of the structural shocks that allows to account for the complex interrelations within the triad of exchange rates, sovereign risks and interest rates. We find that the direction and size of the response of sovereign risk to FX rate movements depend on the type of exchange rate measure we look at and on the size of the net foreign currency exposure of an economy. A depreciation of the domestic currency against the USD increases sovereign risk. In contrast, a depreciation of the effective exchange rate turns out to have only a significant effect on sovereign risk for countries with large negative net foreign currency exposures of the private sector. In this case, a depreciation of the NEER also induces an increase in sovereign risk. We conclude that the 'financial channel' is more important in the transmission of exchange rate shocks to sovereign risk in comparison with the traditional 'net trade channel'.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: DIW Discussion Papers ; No. 1792

Classification and Topics

• Classification: Wirtschaft ; Multiple or Simultaneous Equation Models: Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models ; Asset Pricing; Trading Volume; Bond Interest Rates ; International Financial Markets ; Pension Funds; Non-bank Financial Institutions; Financial Instruments; Institutional Investors
• Subject: exchange rates ; sovereign risk ; foreign currency exposure ; structural VAR

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Bernoth, Kerstin ; Herwartz, Helmut
• Event: Veröffentlichung
• (who): Deutsches Institut für Wirtschaftsforschung (DIW)
• (where): Berlin
• (when): 2019

Further information

• Handle: http://hdl.handle.net/10419/194108
• Last update: 10.03.2025, 11:42 AM CET