A ratings‐based approach to measuring sovereign risk

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.

The Dynamic Pricing of Sovereign Risk in Emerging Markets: Fundamentals and Risk Aversion

“…The incremental improvement with our innovative market based approach rests upon the incorporation of information updates based on real-time economic data and rating agencies' shorter-term watchlists and outlooks. We find that accounting for these information releases substantially improves the information content of our sovereign risk measure over the pure ratings based alternative introduced by Remolona, Scatigna and Wu (2007b).…”

“…In this study, we extend the RIEL measure of Remolona, Scatigna and Wu (2007b) (henceforth, RSW-RIEL) for sovereign default risk because the relevant information for assessing an issuer's creditworthiness arrives at a higher frequency than that based solely on sovereign ratings guidance, which by rating agencies' own admission are slow to adjust to the arrival of new information in the market. Altman and Rijken (2004) suggest that rating agencies focus on a long-term horizon (in using a "through-the -cycle" rating methodology) and thus aim to respond only to the perceived permanent component of credit-quality changes in their ratings guidance.…”

“…We apply this decomposition framework to investigate whether expected losses depend on the fundamentals of issuers' creditworthiness and the default risk premia on factors that affect investors' risk aversion. To do so, we build upon and extend t he concept of ratings-implied expected loss introduced by Remolona, Scatigna and Wu (2007b), a concept which relies critically on the information content of credit ratings and the default and recovery histories of rated bonds. The advantage of such information is that it is information to which market participants react in pricing credit risk.…”

Transparent and Unique Sovereign Default Risk Assessment

“… See Longstaff, Pan, Pedersen and Singleton (2007).8 SeeOshino and Saruwatari (2005).9 These includeHaugh, Ollivaud and Turner's (2009) discussion of debt service relative to tax receipts in the Euro area; Hilscher and Nobusch (2010) emphasis on the volatility of terms of trade; and Segoviano, Caceres and Guzzo's (2010) analysis of debt sustainability and the management of a sovereign's balance sheet.10 For example,Remolona, Scatigna and Wu (2008) reach this conclusion after using sovereign credit ratings and historical default rates provided by rating agencies to construct a measure of ratings implied expected loss. 11 To be fair, S&P in a Reuter's article dated January 14, 2009 warned Greece, Spain and Ireland that their ratings could be downgraded further as economic conditions deteriorated.…”

Essays on government debt financing costs

“…For corporate issuers several papers use the expected default frequencies provided by Moody's KMV (e.g. Amato [2005]; Berndt et al [2005]; Kim et al Still another possibility, advocated byRemolona et al [2008], is to use historical default frequencies for given rating levels, which are published for different time horizons by rating agencies.Another line of the literature instead tries to estimate the default risk component by aiming to separate it from other components in spreads. These studies usually assume a dynamic process for the arrival rate of credit events (or for the credit spread itself) under a risk-neutral (objective) and an observed (subjective) measure.…”