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

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    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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    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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    Web page: http://www.capco.com/
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    1. Jamal Ibrahim Haidar, . "Sovereign Credit Risk in the Euro Zone," Working Paper 407736, Harvard University OpenScholar.
    2. Babbel, D.F., 1996. "Insuring Sovereign Debt Against Default," World Bank - Discussion Papers 328, World Bank.
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    11. Dale F. Gray & Robert C. Merton & Zvi Bodie, 2006. "A New Framework for Analyzing and Managing Macrofinancial Risks of an Economy," NBER Working Papers 12637, National Bureau of Economic Research, Inc.
    12. Jens Hilscher & Yves Nosbusch, 2010. "Determinants of Sovereign Risk: Macroeconomic Fundamentals and the Pricing of Sovereign Debt," Review of Finance, European Finance Association, vol. 14(2), pages 235-262.
    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. Smith, Roy C. & Walter, Ingo, 2003. "Global Banking," OUP Catalogue, Oxford University Press, edition 2, number 9780195134360, December.
    16. Udaibir S Das & Michael G. Papaioannou & Christoph Trebesch, 2010. "Sovereign Default Risk and Private Sector Access to Capital in Emerging Markets," IMF Working Papers 10/10, International Monetary Fund.
    17. Feder, Gershon & Just, Richard & Ross, Knud, 1981. "Projecting Debt Servicing Capacity of Developing Countries," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 16(05), pages 651-669, December.
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