Toward a Bottom-Up Approach to Assessing Sovereign Default Risk: An Update

Journal of Applied Finance, Fall/Winter 2011, Volume 21, Issue 2, pp. 5-19

Posted: 8 Aug 2012

See all articles by Edward I. Altman

Edward I. Altman

New York University (NYU) - Salomon Center; New York University (NYU) - Department of Finance

Herbert A. Rijken

Vrije Universiteit Amsterdam (Free University)

Date Written: 2011

Abstract

We propose a totally new approach toward assessing sovereign risk by examining rigorously the health and aggregate default risk of a nation’s private corporate sector. Models such as our new Z-Metrics™ approach can be utilized to measure the median probability of default of the non-financial sector cumulatively for five years, both as an absolute measure of corporate risk vulnerability and a relative measure compared to other sovereigns and to the market’s assessment via the now liquid credit-default-swap market. Specifically, we measure the default probabilities of listed corporate entities in nine European countries, and the USA, as of 2009 and 2010. These periods coincide with the significant rise in concern with sovereign default risk in the Euro country sphere. We conclude that our corporate health index of the private sector measured at periods prior to the explicit recognition by most credit professionals, not only gave an effective early warning indicator but provided a mostly appropriate hierarchy of relative sovereign risk. Policy officials should, we believe, nurture, not penalize, the tax revenue paying and jobs generating private sector when considering austerity measures of distressed sovereigns.

Keywords: Sovereign risk, Aggregate default risk, Z-Metrics™, Credit-default-swap, Euro Region

Suggested Citation

Altman, Edward I. and Rijken, Herbert A., Toward a Bottom-Up Approach to Assessing Sovereign Default Risk: An Update (2011). Journal of Applied Finance, Fall/Winter 2011, Volume 21, Issue 2, pp. 5-19, Available at SSRN: https://ssrn.com/abstract=2126238

Edward I. Altman (Contact Author)

New York University (NYU) - Salomon Center ( email )

44 West 4th Street
New York, NY 10012
United States
212-998-0709 (Phone)
212-995-4220 (Fax)

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Herbert A. Rijken

Vrije Universiteit Amsterdam (Free University) ( email )

De Boelelaan 1105
Amsterdam, 1081HV
Netherlands
+31 20 5986101/6060 (Phone)
+31 20 5986020 (Fax)

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