Exchange Rate Shocks and the Dynamics of International Asset-Backed Securities (ABS)

This article presents a practitioner-relevant view on the response of international asset-backed securities (ABS) spreads to exchange rate shocks. The author documents that positive exchange rate shocks tighten international ABS spreads across maturities; the tightening is more pronounced for lower-rated ABS. Thus, the spread-reducing effects of positive exchange rate shocks are larger for lower-rated international ABS. The author argues that this phenomenon relates to the potential of foreign-currency appreciation to induce risk-on sentiments in favor of the riskier foreign securities experiencing the foreign-currency appreciation, which subsequently lowers ABS spreads. For other variables, the author finds that the interaction between measures of risk aversion in the equities market-VIX-and in the bond market-MOVE-is important in explaining the dynamics of international ABS spreads. Specifically, a positive shock to these risk aversion measures triggers a flight to safety, which subsequently elevates international ABS spreads.