Can dual-currency sovereign CDS predict exchange rate returns?

This paper examines both the time-series and cross-sectional variation in the difference between US dollar and Euro denominated sovereign CDS spreads for a group of Eurozone countries. We find that the spread difference between dual-currency sovereign CDS significantly affects the bilateral exchange rate returns. In addition, the difference could predict the cumulative exchange rate returns up to 10 days. The results strongly suggest that the difference contains important information for the exchange rate dynamics at various phases of the crisis.

► First study to examine the spread difference between dual-currency sovereign CDS in the crisis. ► Difference between dual-currency sovereign CDS significantly affects exchange rate returns. ► The difference predicts the cumulative exchange rate returns up to 10 days in a time series regression. ► The difference is significant for the exchange rate return with macroeconomic conditions.