Sovereign Adaptive Risk Modeling and Implications for the Eurozone GREXIT Case

In the wake of the 2008 financial crisis, the Financial Stability Board (FSB) and the Basel Committee on Banking Supervision (BCBS) created a list of systemically important financial institutions (SIFIs) with the intention of determining which financial institutions were important enough to the global market that their failure would result in systemic collapse. In this work, we create a model that modifies the BCBS’s five indicators of size, interconnectedness, cross-jurisdictional activities, complexity, and substitutability and apply these measures of systemic stress to governments. Although the cross-jurisdictional activities and size were almost identical to the SIFI calculations, the others had to be adapted to mirror the intent of the BCBS. Interconnectedness is calculated by simulation of what would happen to nearby countries if a country defaulted. Substitutability is estimated by the number of services that would no longer be provided if the government ceased to exist. Complexity is market-based and is derived from credit default swap (CDS) spreads. The original application of the model was to track the systemic interdependence of the Eurozone, with particular emphasis on the case of Greece. We anticipate that this model can be used in regional fiscal situations beyond the Eurozone.