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A ratings-based approach to measuring sovereign risk

Author

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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)

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.

Suggested Citation

  • 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.
  • Handle: RePEc:ijf:ijfiec:v:13:y:2008:i:1:p:26-39
    DOI: 10.1002/ijfe.357
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    References listed on IDEAS

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    Cited by:

    1. Zalán Kocsis & Dénes Nagy, 2011. "Variance decomposition of sovereign CDS spreads," MNB Bulletin (discontinued), Magyar Nemzeti Bank (Central Bank of Hungary), vol. 6(3), pages 36-50, October.
    2. Jan Bruha & Evžen Kocenda, 2017. "Financial Stability in Europe: Banking and Sovereign Risk," CESifo Working Paper Series 6453, CESifo Group Munich.
    3. Ballester, Laura & González-Urteaga, Ana, 2017. "How credit ratings affect sovereign credit risk: Cross-border evidence in Latin American emerging markets," Emerging Markets Review, Elsevier, vol. 30(C), pages 200-214.
    4. Dötz, Niko & Fischer, Christoph, 2010. "What can EMU countries' sovereign bond spreads tell us about market perceptions of default probabilities during the recent financial crisis?," Discussion Paper Series 1: Economic Studies 2010,11, Deutsche Bundesbank.
    5. Fausto Hernández-Trillo & Ricardo Smith-Ramírez, 2009. "Credit Ratings in the Presence of Bailout: The Case of Mexican Subnational Government Debt," ECONOMIA JOURNAL, THE LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION - LACEA, vol. 0(Fall 2009), pages 45-79, August.
    6. Chiarella, Carl & ter Ellen, Saskia & He, Xue-Zhong & Wu, Eliza, 2015. "Fear or fundamentals? Heterogeneous beliefs in the European sovereign CDS market," Journal of Empirical Finance, Elsevier, vol. 32(C), pages 19-34.
    7. Edward I. Altman & Herbert A. Rijken, 2011. "Toward a Bottom‐Up Approach to Assessing Sovereign Default Risk," Journal of Applied Corporate Finance, Morgan Stanley, vol. 23(1), pages 20-31, January.
    8. Owen, Sian & Yawson, Alfred, 2010. "Human development and cross-border acquisitions," Journal of Empirical Finance, Elsevier, vol. 17(4), pages 689-701, September.
    9. Johannes Fedderke, 2013. "Promotion and Relegation between Country Risk Classes as Maintained by Country Risk Rating Agencies," Working Papers 376, Economic Research Southern Africa.
    10. 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.
    11. 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.
    12. 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.
    13. Irvin W. Morgan Jr & James P. Murtagh, 2012. "An analysis of global credit risk spreads during crises," Managerial Finance, Emerald Group Publishing, vol. 38(3), pages 341-358.
    14. Bernal, Oscar & Girard, Alexandre & Gnabo, Jean-Yves, 2016. "The importance of conflicts of interest in attributing sovereign credit ratings," International Review of Law and Economics, Elsevier, vol. 47(C), pages 48-66.
    15. 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 (Central Bank of Hungary).

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