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Toward a bottom-up approach to assessing sovereign default risk: an update

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  • Altman, Edward

    ()
    (Stern School of Business New York University)

  • Rijken, Herbert

    ()
    (Vrije University Amsterdam)

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    Abstract

    We propose a totally new approach toward assessing sovereign risk by examining rigorously the health and aggregate default risk of a nation’s private corporate sector. Models such as our new Z-Metrics™ approach can be utilized to measure the median probability of default of the non-financial sector cumulatively for five years, both as an absolute measure of corporate risk vulnerability and a relative measure compared to other sovereigns and to the market’s assessment via the now liquid credit-default-swap market. Specifically, we measure the default probabilities of listed corporate entities in eleven European countries, and the U.S., as of 2008-2010. These periods coincide with the significant rise in concern with sovereign default risk in the euro country sphere. We conclude that our corporate health index of the private sector measured at periods prior to the explicit recognition by most credit professionals, not only gave an effective early warning indicator but provided a mostly appropriate hierarchy of relative sovereign risk. Policy officials should, we believe, nurture, not penalize, the tax revenue paying and jobs generating private sector when considering austerity measures of distressed sovereigns.

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    Bibliographic Info

    Article provided by Capco Institute in its journal Journal of Financial Transformation.

    Volume (Year): 34 (2012)
    Issue (Month): ()
    Pages: 19-29

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    Handle: RePEc:ris:jofitr:1508

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    Related research

    Keywords: Sovereign Risk; Financial Crisis; Default Probability; Z-Metrics;

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    References

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    1. Edda Zoli & Silvia Sgherri, 2009. "Euro Area Sovereign Risk During the Crisis," IMF Working Papers 09/222, International Monetary Fund.
    2. Gennaioli, Nicola & Martin, Alberto & Rossi, Stefano, 2010. "Sovereign Default, Domestic Banks and Financial Institutions," CEPR Discussion Papers 7955, C.E.P.R. Discussion Papers.
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    11. 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.
    12. Babbel, D.F., 1996. "Insuring Sovereign Debt Against Default," World Bank - Discussion Papers 328, World Bank.
    13. Eli M. Remolona & Michela Scatigna & Eliza Wu, 2008. "A ratings-based approach to measuring sovereign risk," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 13(1), pages 26-39.
    14. Pomerleano, Michael, 1998. "The East Asia crisis and corporate finances : the untold micro story," Policy Research Working Paper Series 1990, The World Bank.
    15. Miguel A. Segoviano Basurto & Carlos Caceres & Vincenzo Guzzo, 2010. "Sovereign Spreads," IMF Working Papers 10/120, International Monetary Fund.
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