Sovereign default risk assessment

We propose a new approach toward assessing sovereign risk by examining rigorously the health and aggregate default risk of a nation's private corporate sector. Models can be utilised to measure the 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 credit-default-swap market. Specifically, we measure the default probabilities of listed corporate entities in ten European countries, and the USA, covering the recent global financial crisis period and the subsequent European sovereign crisis, the latter of which is still with us today, in 2013. We conclude that our transparent corporate health index measured at periods prior to and after the explicit recognition by most credit professionals, not only gave an effective early warning indicator but provided an appropriate hierarchy of relative sovereign risk. Policy officials should, we believe, nurture, not penalise, the tax revenue paying and jobs generating private sector when considering austerity measures of distressed sovereigns.