Measuring Sovereign Risk in Turkey: An Application of the Contingent Claims Approach

Abstract

This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.Improved macroeconomic conditions and changes to the asset-liability structure on Turkish balance sheets since the 2001 crisis have improved Turkey's overall sovereign risk profile. Nonetheless, the country remains subject to bouts of volatility, as evidenced most recently in the May/June 2006 market turbulence. This paper examines these changes in Turkey's risk profile using the Contingent Claims Approach (CCA), to quantify the evolution of Turkey's sovereign risk, relate risk indicators to market prices of risk, and conduct scenario analyses to assess the effects of potential market volatility and policy adjustments on key risk indicators.

A Critique of the Contingent Claims Approach to Sovereign Risk Analysis

“…According to Gray et al (2007) domestic debt and monetary base can be combined to calculate local currency liabilities (LCL), which is assumed to be the "equity-like" portion of the balance sheet. The volatility estimation is performed according to the formulas provided by Keller et al (2007) and Gray and Malone (pp. 127, 2008).…”

“…In addition, we have the study by Keller et al (2007) applying the CCA to Turkey over the [2002][2003][2004][2005][2006] period. The authors also confirm that the CCA model outputs are highly correlated with market data (CDS and EMBI).…”

Contingent Liabilities and Sovereign Risk: Evidence from Banking Sectors

“…Fisher and Gray (2006) use the CCA approach to measure sovereign and banking sector risk in Indonesia. Keller, Kunzel, Souto (2007) apply the framework to quantify the evolution of Turkey's sovereign risk. Gray and Walsh (2008) apply the CCA analysis to derive risk indicators for the Chilean banking system.…”

Measuring systemic risk in the Colombian financial system : a systemic contingent claims approach

“…The results of this modified framework appear to be appropriate for countries without developed equity markets, at least in the sense that they reflect episodes of financial stress accordingly. Additionally, other studies like Gray & Jones (2006) on Indonesia and Keller et al (2007) on Turkey, have used the BSM model not only to analyze banking sector risk, but to analyze sovereign risk using government balance sheet information.…”