Abstract
We explore seven main signals for anticipating Country Risk. One is the credit rating. A second is the country’s stock market. A third is a sharp rise in the current account to GDP and debt/GDP ratios. The fourth is a bunching of debt payments in the current year, with a rise of the debt servicing ratio and a drop in reserve assets. The fifth is rising bond yields and their spread over the “risk-free rate.” The sixth is a rising cost of Credit Default Swaps. The seventh is an increase in the VIX index. We assess the strengths and weaknesses of these indicators, concluding that even the most seemingly promising signals have significant limitations. While it may sound appealing to watch multiple potential warning signs, these indicators do not consistently serve as reliable early warning signals. A case study examines in detail the impact of CDS prices in five countries.
Access this chapter
Tax calculation will be finalised at checkout
Purchases are for personal use only
Notes
- 1.
A CDS spread of 400 bp for five-year Italian debt means that default insurance for a notional amount of EUR 1 million costs EUR 40,000 per annum; this premium is paid quarterly.
- 2.
The case study is a summary of the MSc FMI’s Research Thesis of Antonino Conforto and Pietro Veronesi, under guidance from Michel H. Bouchet. Skema Business School. December 2017.
References
Aronovich, Selmo. 1999. “Country Risk Premium: Theoretical Determinants and Emperical Evidence for Latin American Countries.” Revista Brasileira de Economia 53 (4): 463–498.
Bellas, Dimitri, Michael G. Papaioannou, and Iva Petrova. 2010. “Determinants of Emerging Market Sovereign Bond Spreads: Fundamentals vs Financial Stress.” IMF Working Paper WP10/281. International Monetary Fund.
Crooks, Nathan. 2017. “Venezuela’s Default Risk Is Rising.” Bloomberg, July 5.
Deventer, John. 2015. “Sovereign Credit Default Swaps and the European Commission Short Sale Ban, 2010–2014.” Blog, January 9. https://seekingalpha.com/instablog/420043-donald-van-deventer/3626475-sovereign-credit-default-swaps-and-the-european-commission-short-sale-ban-2010minus-2014.
Eisen, Ben. 2017. “Wall Street’s Volatility Pioneer Searches for Latest Fear Trade.” The Wall Street Journal, March 10.
European Commission. 2011. “Regulation on Short Selling and Credit Default Swaps—Frequently Asked Questions,” October 19. http://europa.eu/rapid/press-release_MEMO-11-713_fr.htm.
Fitch IBCA. 1998. “Asia: Agencies’ Harsh Lessons in a Crisis.” Press Release, January 13. www.bradynet.com/e312.html. January 14.
Flores, Esteban. 2010. “Do Sovereign Credit Rating Changes Have Spillover Effects on Other Countries?” Economics Department, Stanford University, May 9.
Glasserman, Paul. 2000. “Probability Model of Credit Risk. Columbia Business School.” https://www0.gsb.columbia.edu/faculty/pglasserman/B6014/Prob_Credit.pdf.
Grossman, Robert J., and Martin Hensen. 2010. “CDS Spreads and Default Risk: Interpreting the Signals.” Fitch Ratings Special Report, October 12.
International Monetary Fund. 1998. “The Asian Crisis: Causes and Cures.” Finance and Development 35 (2). http://www.imf.org/external/pubs/ft/fandd/1998/06/imfstaff.htm.
International Monetary Fund. 2017. “Key Questions on Approval in Principle and Greece,” July 20.
Mandelbrot, Benoit, and Nassim Taleb. 2006. “A Focus on the Exceptions That Prove the Rule.” Financial Times, March 23.
Moody’s Investors Services. 2017. “Sovereign Default and Recovery Rates, 1983–2016.” Data Report, June 30.
Mutual Fund Directors Forum. 2017. “The Role of the Mutual Fund Director in the Oversight of the Risk Management Function.” http://www.mfdf.org/images/Newsroom/Risk_Publication_2017.pdf.
Salomao, Juliana. 2017. “Sovereign Debt Renegotiation and Credit Default Swaps.” Journal of Monetary Economics 90 (C): 50–63.
Shiller, Robert. 2014. “Robert Shiller Says Markets Have Become More Prone to Bubbles.” Interview with Robert Stowe England. Institutional Investor, February 27.
Trading Economics. 2017. https://tradingeconomics.com/south-korea/rating.
US Senate. 2002. “Hearing, 107th Congress,” Washington, DC, February 5. https://Fr.Scribd.Com/Document/341381004/Senate-Hearing-107th-Congress-Retirement-Insecurity-401-K-Crisis-At-Enron; see also US Senate Hearing March 20, 2002. https://www.gpo.gov/fdsys/pkg/CHRG-107shrg79888/pdf/CHRG-107shrg79888.pdf.
Vanguard. 2013. “Vanguard Research. Emerging Market Bonds-Beyond the Headlines,” May. http://www.vanguard.com/pdf/s710.pdf.
Veronesi, Pietro, and Antonino Conforto. 2017. “Country Risk: In Search of Early Warning Signals.” SKEMA Master of Science-Financial Markets and Investments. Research Thesis Under the Direction Michel Henry Bouchet.
Weltman, Jeremy. 2012. “Country Risk: Is This the End for CDS Spreads as a Useful Measure of Sovereign Risk?” Euromoney, November 16.
Wigglesworth, Robin. 2017. “The Fearless Market Ignores Perils Ahead.” Financial Times, April 18.
Yardeni, Edward, and Mali Quintana. 2017. “Global Economic Briefing: Central Bank Balance Sheets.” Yardeni Research, Inc., December 8.
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
Copyright information
© 2018 The Author(s)
About this chapter
Cite this chapter
Bouchet, M.H., Fishkin, C.A., Goguel, A. (2018). In Search of Early Warning Signals of Country Risk: Focusing on Market Price Signals. In: Managing Country Risk in an Age of Globalization. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-319-89752-3_13
Download citation
DOI: https://doi.org/10.1007/978-3-319-89752-3_13
Published:
Publisher Name: Palgrave Macmillan, Cham
Print ISBN: 978-3-319-89751-6
Online ISBN: 978-3-319-89752-3
eBook Packages: Economics and FinanceEconomics and Finance (R0)