Burton G. Malkiel, Fred D. Arditti, Manak C. Gupta, Session Topic: Recognizing the Impact of Growth: Discussion, The Journal of Finance, Vol. 30, No. 2, Papers and Proceedings of the Thirty-Third Annual Meeting of the American Finance Association, San Francisco, California, December 28-30, 1974 (May, 1975), pp. 548-555

This paper uncovers a novel component for exchange rate predictability based on the price difference between sovereign credit default swaps denominated in different currencies. This new forecasting variable – the credit-implied risk premium – captures the expected currency depreciation conditional on a severe but rare credit event. Using data for 16 Eurozone countries, we find that the credit-implied risk premium positively forecasts the dollar-euro exchange rate return at various horizons. Moreover, a currency strategy that exploits the informative content of our predictor generates substantial out-of-sample economic value against the naïve random walk benchmark.