Quanto CDS Spreads

Quanto CDS spreads are differences in CDS premiums of the same reference entity but in different currency denominations. Such spreads can arise in arbitrage-free models and depend on the risk of a jump in the exchange rate upon default of the underlying and the covariance between the exchange rate and default risk. We develop a model that separates the contribution of these two effects to quanto spreads and apply it to four eurozone sovereigns. Furthermore, using our model estimates, we provide evidence that quanto effects can explain a significant part of the yield spread between eurozone sovereign bonds issued in Euro and U.S. dollar. Our findings suggest that comparing bond yields across currency denominations using standard FX forward hedges misses an important quanto effect component.