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Currency Redenomination Risk

Published online by Cambridge University Press:  19 July 2023

Lukas Kremens
Lukas Kremens*
Affiliation:
University of Washington Foster School of Business
*
lkremens@uw.edu
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Abstract

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A eurozone exit or breakup exposes bondholders to currency redenomination risk. I quantify redenomination risk since the sovereign debt crisis: It contributes substantially to credit spreads around changes in government in France and Italy. Bond prices suggest that markets have priced a potential Italian exit as isolated, and a French one as a breakup. Unlike conventional default risk, redenomination risk can be negative depending on the strength of the national “shadow” currency. Countries with strong shadow currencies earn breakup-insurance premia from the eurozone analog of “exorbitant privilege.” Yield effects are quantitatively large for implied exit probabilities as low as 1%.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , First View , pp. 1 - 31
Creative Commons
Creative Common License - CCCreative Common License - BY
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence (http://creativecommons.org/licenses/by/4.0), which permits unrestricted re-use, distribution and reproduction, provided the original article is properly cited.
Copyright
© The Author(s), 2023. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

I thank an anonymous referee, Patrick Augustin, Philip Bond, Bernard Dumas, Daniel Ferreira, Thierry Foucault (the editor), Alex Jeanneret, Zhengyang Jiang, Christian Julliard, Lorena Keller, Victor Lyonnet, Ian Martin, Francesco Nicolai, Martin Oehmke, Gianluca Rinaldi, Andrea Vedolin, Alex Weissensteiner, Pete Zimmerman, and seminar/conference participants at LSE, Dauphine, EFA, HEC, Collegio Carlo Alberto, Chicago Booth, LBS, HBS, Boston College, Austin, UW, UIUC, Bocconi, UNC, and the VSFX for helpful comments.

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