Description:
We study the relationship between cross-sectional sovereign credit risk and currency spot prices. We find that past (up to 12-month average) sovereign credit risk, measured by sovereign credit default swap (CDS) spreads, predicts future currency spot returns. In particular, we document a significant cross-sectional currency portfolio spread in excess of the risk-free rate of return (up to 9.4% p.a.) between the highest and the lowest quintile sovereign CDS spreads. Overall, our results indicate that sovereign credit risk is systematically important for currency returns. Compared with changes in sovereign CDSs, the level of sovereign CDSs has a persistent e↵ect on currency returns that we label as sovereign momentum e↵ect