Search results

The credit ratings issued by the Big 3 ratings agencies are inaccurate and slow to respond to market changes. This paper aims to develop a rigorous, transparent and robust credit assessment and rating scheme for sovereigns.

This paper develops a regression-based model using credit default swap (CDS) data, and data on financial and macroeconomic variables to estimate sovereign CDS spreads. Using these spreads, the default probabilities of sovereigns can be estimated. The new ratings scheme is then used in conjunction with these default probabilities to assign credit ratings to sovereigns.

The developed model accurately estimates CDS spreads (based on RMSE values). Credit ratings issued retrospectively using the new scheme reflect reality better.

This paper reveals that both macroeconomic and financial factors affect both systemic and idiosyncratic risks for sovereigns.

The developed credit assessment and ratings scheme can be used to evaluate the creditworthiness of sovereigns and subsequently assign robust credit ratings.

The transparency and rigor of the new scheme will result in better and trustworthy indications of a sovereign’s financial health. Investors and monetary authorities can make better informed decisions. The episodes that occurred during the debt crisis could be avoided.

This paper uses both financial and macroeconomic data to estimate CDS spreads and demonstrates that both financial and macroeconomic factors affect sovereign systemic and idiosyncratic risk. The proposed credit assessment and ratings schemes could supplement or potentially replace the credit ratings issued by the Big 3 ratings agencies.

The recent financial and sovereign debt crises around the world have sparked a growing literature on models and empirical estimates of defaultable debt. Frequently households and firms come under default threat, local governments can default, and recently sovereign default threats were eminent for Greece and Spain in 2012–2013. Moreover, Argentina experienced an actual default in 2001. What causes sovereign default risk, and what are the escape routes from default risk? Previous studies such as Arellano (2008), Roch and Uhlig (2013), and Arellano et al. (2014) have provided theoretical models to explore the main dynamics of sovereign defaults. These models can be characterized as threshold models in which there is a convergence toward a good no-default equilibrium below the threshold and a default equilibrium above the threshold. However, in these models aggregate output is exogenous, so that important macroeconomic feedback effects are not taken into account. In this chapter, we (1) propose alternative model variants suitable for certain types of countries in the EU where aggregate output is endogenously determined and where financial stress plays a key role, (2) show how these model variants can be solved through the Nonlinear Model Predictive Control numerical technique, and (3) present some empirical evidence on the nonlinear dynamics of output, sovereign debt, and financial stress in some euro areas and other industrialized countries.

The Covid-19 pandemic has rekindled interest in sovereign debt crises amidst calls for debt relief for developing and emerging countries. But has debt relief lessened the debt burdens of emerging and developing economies? The purpose of this paper is to empirically address this question. In particular, the focus is on the implications of debt relief and institutional qualities for sovereign debt in emerging and developing economies.

The model extends the framework on the probability of default by incorporating the receipt of debt relief by a debtor country. Doing so allows to better explain movements of sovereign defaults relating to debt relief. The model is estimated via the regular probit regression.

The analysis shows that the debt relief provided, thus, far, failed to ease the debt overhang problems of developing and emerging countries and reduced investment. The current debt relief schemes may underscore the prospects of self-enforcing and self-fulfilling sovereign debt crises rather than eliminating the dilemma completely. Regarding the forms of debt relief, the analysis shows that debt forgiveness offers favourable prospects in terms of debt sustainability and economic outcomes than debt rescheduling. Perhaps, the sovereign debt crises, particularly in low-income countries, hinge on insolvency problems rather than transitory illiquidity issues.

Any debt relief mechanism should consider seriously the potential incentive effect that reinforces expectations of future debt-relief initiatives. Importantly, solving the sovereign debt problem requires a programme for sustained investment and economic growth, while not discounting the critical role of prudent debt management policies and institutions.

This study contributes a different angle to the debate on sovereign debt distress. Aside from the structural and economic factors, this study investigates the role of debt management policy in the debtor nation and the implications of debt relief benefits for sovereign risk. The framework also focuses on whether the different forms of debt relief exert distinctive impacts.

This chapter provides a comprehensive overview of the young, but rapidly growing sovereign credit default swap (CDS) market, describes the function, trading, history, market participants, key statistical and stylized facts about CDS prices, determinants, price discovery, and risk issues.

This paper aims to investigate the nexus between banks’ foreign assets and sovereign default risk in a panel of 15 developed economies. The empirical evidence suggests that banks’ foreign exposure is an important determinant of sovereign default probability.

Using data from the consolidated banking statistics (total foreign claims on ultimate risk basis) by the Bank of International Settlements, the author constructs a measure of bank international exposure to peer countries. This measure is then used as the target variable in a panel regression for sovereign credit default swaps. The model includes 15 European and non-European developed economies. Identification is discussed extensively in the paper.

Quantitatively, a 1% increase in banks’ cross-border claims increases sovereign default risk by about 0.19%. The relationship is weaker when banks are more capitalised. On the other hand, governments are more vulnerable to credit risk spillovers from banks’ international portfolios when having higher debt to GDP ratios.

To the best of the author’s knowledge, this is the first paper that attempts explicitly to establish an empirical connection between banks’ international assets and sovereign default risk. To the author’s opinion, this paper represents a contribution to our understanding of how sovereign credit risk spills over across countries. It also extends significantly the existing literature on the determinants of sovereign risk (that primarily focused on fundamentals, market characteristics – such as liquidity – and global factors). This paper ultimately sheds some new light on the role of intermediaries in the international transmission of credit risk, also adding to today’s discussion about the linkages between banks and sovereigns.

When extended to sovereign issuers, the Merton‐type structural model suggests a negative relationship between sovereign credit default swap (CDS) spreads and stock prices. In practice, capital structure arbitrage that exploits such relationships should foster the integration of CDS and the stock market and improve price discovery. This paper studies the dynamic relationship between sovereign CDS spreads and stock prices for seven Asian countries for the period from January 2001 to February 2007. We find a strong negative correlation between the CDS spread and the stock index for most Asian countries. A long‐run equilibrium price relationship is found for China, Korea, and Thailand. The limited integration in other countries may arise from market frictions and model applicability. In terms of price discovery, CDS markets play a leading role in five out of seven countries. Therefore, equity investors should span the CDS market for incremental information. The stock market has a feedback effect for two countries and dominates price discovery for only one country.

This paper aims to provide an overview of the market for corporate and sovereign credit default swaps (CDS), with particular focus on Europe. It studies whether the subprime crisis of 2007/2008 and, particularly, the European debt crisis 2009/2010 led to a differential development on corporate and sovereign CDS markets and investigates the primary use (speculative risk-trading or risk-hedging) of the two markets in recent years.

The authors use aggregate market data on the size of the respective markets and on the structure of market participants and their changes over time to assess the main research question. They enhance existing data from public sources such as the Bank for International Settlements and Depository Trust and Clearing Corporation with their own statistics on European sovereign CDS and combine their conclusions with observations regarding standardisation efforts and regulatory changes in the CDS market.

The authors show that after the subprime crisis 2007/2008 and the European debt crisis 2009/2010, the corporate and sovereign CDS markets developed quite differently. They provide evidence that since mid-2010, market participants started to use the sovereign CDS market more strongly for speculative purposes than for risk-hedging. This shows both in the shift of risk-quality of sovereign CDS contracts and in the changing structure of market participants. The ongoing standardisation and regulation in the CDS market – leading to further increases in transparency and reductions in transaction costs – may be expected to trigger a similar change also for corporate CDS.

Based on a broad variety of market infrastructure data, the authors show a diverging development of corporate and sovereign CDS markets in Europe in recent years. Particularly the sovereign CDS market appears to have shifted from a risk-hedging instrument to being used more strongly for speculative risk-trading. The authors combine their findings with recent regulatory action and market standardisation schemes and draw conclusions for the future development of CDS markets.

This study aims to analyze the impact and effectiveness of the regulation on the European sovereign Credit Default Swap (CDS) market. The European sovereign debt crisis has drawn considerable attention to the CDS market. CDS have the ability of a speculative instrument to bet against a sovereign default. Therefore, the Regulation (EU) No. 236/2012 was introduced as the worldwide first uncovered CDS regulation. It prohibits buying uncovered sovereign CDS contracts in the European Union (EU).

First, this paper measures spread changes of sovereign CDS of the EU member states around regulation specific event dates to detect whether and when European sovereign CDS reacts to regulation announcements and the enforcement of regulation. Second, it compares the CDS long-term stability of the EU sample with a non-EU sample based on 44 non-EU sovereign CDS entities.

The results indicate widening CDS spreads prior to the regulation, and stable CDS spreads following the introduction of the regulation. In particular, sovereign CDS of European crisis-hit entities are stable since the regulation was introduced.

The results show that since the regulation of uncovered CDS in the EU has been enacted, the sovereign CDS market is stable and less volatile. Based on the theory about speculation on uncovered sovereign CDS by betting on the reference entity’s default, the introduction of Regulation (EU) No. 236/2012 appears to be an appropriate measure to stabilize markets and reduce speculation on sovereign defaults.

This paper aims to provide an empirical analysis of the macroeconomic determinants of sovereign bond yield spreads in the Eurozone from 2000 until August 2012, when the Outright Monetary Transactions programme was launched.

The authors constructed an unbalanced panel with quarterly data from 2000 Q1 to 2012 Q2 for the 12 Eurozone countries: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Luxembourg, Italy, The Netherlands, Portugal and Spain. The authors propose a model that explains spreads through the main categories of variables observed in the literature. The relationship between variables is analysed using ordinary least squares and quantile regressions. As discussed by the authors, quantile regressions provide a more precise estimation, given the huge heterogeneity across counties that can be observed in the Eurozone.

Results show that the relationship between sovereign risk and macroeconomic fundamentals is affected by a strong country sentiment effect. The impact of country sentiment on sovereign risk is larger for those countries that were already experiencing higher spreads. Regardless the impact that European Central Bank’s (ECB) intervention had on sovereign risk from 2012, quantile regression results suggest that policy recommendations and goals should be adapted to each country’s market perception.

The results obtained improve on previous findings on this topic (De Grauwe and Ji, 2012) in two ways. First, they show that even introducing every category of determinants found in the literature in the main specification, fundamentals can only partially explain the evolution of sovereign risk in the Eurozone. Second, they find there is a country-sentiment effect that affects the relationship between macroeconomic indicators and sovereign risk. Furthermore, the paper finds that the country-sentiment effect is larger for countries facing high spreads.

Since sovereign ratings provided by credit rating agencies (CRAs) are a key determinant of the interest rates a country faces in the international financial market and once sovereign ratings may have a constraining impact on the ratings assigned to domestic banks or companies, some studies have focused on identifying the determinants of sovereign credit risk assessments provided by CRAs. In particular, this study estimates the effect of fiscal credibility on sovereign risk using four different comprehensive credit rating (CCR) measures obtained from CRAs' announcements and two different fiscal credibility indicators.

We build comprehensive credit rating (CCR) measures to capture sovereign risk. These measures are calculated using sovereign ratings, the rating outlooks and credit watches issued by the three main credit rating agencies (S&P, Moody's and Fitch) for long-term foreign-currency Brazilian bonds. Based on monthly data from 2003 to 2018, we use different econometric estimation techniques in order to provide robust results.

The results indicate that fiscal credibility exerts both short- and long-run effects on sovereign risk perception, and macroeconomic fundamentals are important long-run determinants.

Since fiscal credibility reflects the government's ability to maintain budgetary balance and sustainable public debt, the government should keep its commitment to responsible fiscal policies so as not to deteriorate expectations formed by financial market experts about the fiscal scenario and, thus, to achieve better credit assessments issued by CRAs with respect to sovereign debt bonds. Sovereign credit rating assessment is a voluntary practice. It is up to the country whether they want to apply for a rating assessment or not. Thus, without a sovereign rating, one must find an alternative to measure the sovereign risk of a country. In this sense, an important practical implication that this study provides is that fiscal credibility can be used as a leading indicator of sovereign risk perceptions obtained from CRAs or even as a proxy for sovereign risk.

This paper is the first to verify how important the expectations of financial market experts in relation to the fiscal effort required to keep public debt at a sustainable level (i.e. fiscal credibility) are to sovereign risk perception of credit rating agencies. In this sense, the study is the first to address this relation, and thus it contributes to the literature that seeks to understand the determinants of sovereign ratings in emerging countries.