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A ratings-based approach to measuring sovereign risk

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  • Eli M. Remolona

    (Bank for International Settlements, Representative Office for Asia and the Pacific, 78 th Floor, IFC, 8 Finance St, Central, Hong Kong)

  • Michela Scatigna

    (Bank for International Settlements, Representative Office for Asia and the Pacific, 78 th Floor, IFC, 8 Finance St, Central, Hong Kong)

  • Eliza Wu

    (School of Banking and Finance, University of New South Wales, Sydney, NSW #2052, Australia)

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Abstract

We propose a new approach to measuring sovereign default risk. We use sovereign credit ratings and historical default rates provided by credit rating agencies to construct a measure of ratings-implied expected loss. We compare our measure of expected loss from sovereign defaults with stand-alone credit ratings and also examine its relationship with credit default swap spreads. We show that our measure is more informative for measuring sovereign risk. We re-examine the fundamental determinants of sovereign risk and find further evidence to support the debt intolerance and original sin explanations for country risk. This study contributes an improved understanding of the value of sovereign credit rating teams in assessing the long-term country risks accompanying emerging market investments. Copyright © 2007 John Wiley & Sons, Ltd.

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File URL: http://hdl.handle.net/10.1002/ijfe.357
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Bibliographic Info

Article provided by John Wiley & Sons, Ltd. in its journal International Journal of Finance & Economics.

Volume (Year): 13 (2008)
Issue (Month): 1 ()
Pages: 26-39

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Handle: RePEc:ijf:ijfiec:v:13:y:2008:i:1:p:26-39

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Web page: http://www.interscience.wiley.com/jpages/1076-9307/

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  1. Carmen M. Reinhart & Kenneth S. Rogoff & Miguel A. Savastano, 2003. "Debt Intolerance," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 1-74.
  2. Darrell Duffie & Lasse Heje Pedersen & Kenneth J. Singleton, 2003. "Modeling Sovereign Yield Spreads: A Case Study of Russian Debt," Journal of Finance, American Finance Association, vol. 58(1), pages 119-159, 02.
  3. António Afonso, 2002. "Understanding the Determinants of Government Debt Ratings: Evidence for the Two Leading Agencies," Working Papers Department of Economics 2002/02, ISEG - School of Economics and Management, Department of Economics, University of Lisbon.
  4. Patrick McGuire & Martijn A Schrijvers, 2003. "Common factors in emerging market spreads," BIS Quarterly Review, Bank for International Settlements, December.
  5. Claudio Borio & Frank Packer, 2004. "Assessing new perspectives on country risk," BIS Quarterly Review, Bank for International Settlements, December.
  6. Oshiro, Naoto & Saruwatari, Yasufumi, 2005. "Quantification of sovereign risk: Using the information in equity market prices," Emerging Markets Review, Elsevier, vol. 6(4), pages 346-362, December.
  7. Baek, In-Mee & Bandopadhyaya, Arindam & Du, Chan, 2005. "Determinants of market-assessed sovereign risk: Economic fundamentals or market risk appetite?," Journal of International Money and Finance, Elsevier, vol. 24(4), pages 533-548, June.
  8. Barry Eichengreen & Ricardo Hausmann & Ugo Panizza, 2003. "Currency Mismatches, Debt Intolerance and Original Sin: Why They Are Not the Same and Why it Matters," NBER Working Papers 10036, National Bureau of Economic Research, Inc.
  9. Diaz Weigel, Diana & Gemmill, Gordon, 2006. "What drives credit risk in emerging markets? The roles of country fundamentals and market co-movements," Journal of International Money and Finance, Elsevier, vol. 25(3), pages 476-502, April.
  10. Morris Goldstein & Philip Turner, 2004. "Controlling Currency Mismatches in Emerging Markets," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 373.
  11. International Monetary Fund, 1996. "The Economic Content of Indicators of Developing Country Creditworthiness," IMF Working Papers 96/9, International Monetary Fund.
  12. Antje Berndt & Rohan Douglas & Darrell Duffie & Mark Ferguson & David Schranz, 2005. "Measuring default risk premia from default swap rates and EDFs," BIS Working Papers 173, Bank for International Settlements.
  13. Joost Driessen, 2005. "Is Default Event Risk Priced in Corporate Bonds?," Review of Financial Studies, Society for Financial Studies, vol. 18(1), pages 165-195.
  14. Kim, Suk-Joong & Wu, Eliza, 2008. "Sovereign credit ratings, capital flows and financial sector development in emerging markets," Emerging Markets Review, Elsevier, vol. 9(1), pages 17-39, March.
  15. Amar Gande & David Parsley, 2003. "News Spillovers in the Sovereign Debt Market," Working Papers 062003, Hong Kong Institute for Monetary Research.
  16. Marian Micu & Eli M Remolona & Philip D. Wooldridge, 2006. "The price impact of rating announcements: which announcements matter?," BIS Working Papers 207, Bank for International Settlements.
  17. Michael T. Gapen & Dale F. Gray & Cheng Hoon Lim & Yingbin Xiao, 2005. "Measuring and Analyzing Sovereign Risk with Contingent Claims," IMF Working Papers 05/155, International Monetary Fund.
  18. Sy, Amadou N. R., 2002. "Emerging market bond spreads and sovereign credit ratings: reconciling market views with economic fundamentals," Emerging Markets Review, Elsevier, vol. 3(4), pages 380-408, December.
  19. Altman, Edward I. & Rijken, Herbert A., 2004. "How rating agencies achieve rating stability," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2679-2714, November.
  20. Richard Cantor & Frank Packer & Kevin Cole, 1997. "Split ratings and the pricing of credit risk," Research Paper 9711, Federal Reserve Bank of New York.
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Cited by:
  1. Zalán Kocsis & Dénes Nagy, 2011. "Variance decomposition of sovereign CDS spreads," MNB Bulletin, Magyar Nemzeti Bank (the central bank of Hungary), vol. 6(3), pages 36-50, October.
  2. Piotr Kębłowski, 2011. "The Behaviour of Exchange Rates in the Central European Countries and Credit Default Risk Premiums," Central European Journal of Economic Modelling and Econometrics, CEJEME, vol. 3(4), pages 221-236, December.
  3. Edward I. Altman & Herbert A. Rijken, 2013. "Sovereign default risk assessment," International Journal of Banking, Accounting and Finance, Inderscience Enterprises Ltd, vol. 5(1/2), pages 6-27.
  4. Zalán Kocsis, 2013. "Global, Regional and Country-Specific Components of Financial Market Indicators: An Extraction Method and Applications," MNB Working Papers 2013/3, Magyar Nemzeti Bank (the central bank of Hungary).
  5. Altman, Edward & Rijken, Herbert, 2012. "Toward a bottom-up approach to assessing sovereign default risk: an update," Journal of Financial Transformation, Capco Institute, vol. 34, pages 19-29.
  6. Owen, Sian & Yawson, Alfred, 2010. "Human development and cross-border acquisitions," Journal of Empirical Finance, Elsevier, vol. 17(4), pages 689-701, September.
  7. Fausto Hernández-Trillo & Ricardo Smith-Ramírez, 2009. "Credit Ratings in the Presence of Bailout: The Case of Mexican Subnational Government Debt," JOURNAL OF LACEA ECONOMIA, LACEA - LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION.

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