The Impact of Banking and Sovereign Debt Crisis Risk in the Eurozone on the Euro/US Dollar Exchange Rate

I study the impact of financial crisis risk in the eurozone on the euro/US dollar exchange rate. Using daily data from 3 July 2006 to 30 September 2010, I find that the euro depreciates against the US dollar when banking or sovereign debt crisis risk increases in the eurozone. While the external value of the euro is more sensitive to changes in sovereign debt crisis risk in vulnerable member countries than in stable member countries, the impact of banking crisis risk is similar for both country blocs. Moreover, rising default risk of medium and large eurozone banks leads to a depreciation of the euro while small banks’ default risk has no significant impact, showing the relevance of systemically important banks with regards to the exchange rate.

26. March 2012

Authors Stefan Eichler

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