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.
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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.
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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
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