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Measuring Sovereign Credit Risk of the EU countries

Author

Listed:
  • Vojtěch Siuda

    (Czech National Bank; Faculty of Finance and Accounting, University of Economics in Prague, Prague, Czech Republic)

  • Milan Szabo

    (Czech National Bank; Faculty of Finance and Accounting, University of Economics in Prague, Prague, Czech Republic)

Abstract

European countries have increased significantly their public debt since the Global Financial Crisis. The increasing trend and the high concentration of public debt in portfolios of financial institutions can lead to a financial turmoil we witnessed during the European Sovereign Debt Crisis. Financial stability authorities therefore look for models to measure the sovereign credit risk and develop “what-if” scenarios to assess a potential repercussion of a financial institution rescue or of an economic contraction on sovereign credit risk. The presented article introduces adjustments to the sovereign contingent claims analysis that is based on the Merton´s Credit Risk Model and the Black-Scholes option pricing techniques. The article proposes adjustments by introducing a new view on a stylised liability side of a central government balance sheet, seniority of its items, and a new proxy for risk measure of junior claims. We show reliable results using derived risk sensitivities for 20 EU countries with decent forward looking ability and propose potential stress-testing framework with an application for the Czech Republic.

Suggested Citation

  • Vojtěch Siuda & Milan Szabo, 2021. "Measuring Sovereign Credit Risk of the EU countries," Journal of Central Banking Theory and Practice, Central bank of Montenegro, vol. 10(3), pages 169-192.
    • Handle: RePEc:cbk:journl:v:10:y:2021:i:3:p:169-192
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    sovereign credit risk; contingent claims analysis; stresstesting.;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
    • G01 - Financial Economics - - General - - - Financial Crises

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