The impact of a sovereign default within the Euro zone on the exchange rate

We use quanto credit default swaps to analyze the impact of a credit event in the Euro zone on the Euro-Dollar exchange rate. In light of the European debt crisis, market participants are willing to pay more for protection against a sovereign credit event if the payment in such an event is denominated in US-Dollar rather than in Euro, because they expect the Euro to depreciate in the wake of the credit event. We use this CDS price difference to calculate the implied change of the exchange rate conditional on a credit event of a member of the Euro zone. We find that the implied effect is quite heterogeneous across the different countries. In addition, we identify three country groups for which the implied effect on the exchange rate developed similarly over the time horizon of our data set