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An Explained Extreme Gradient Boosting Approach for Identifying the Time-Varying Determinants of Sovereign Risk

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Listed:
  • Iader Giraldo
  • Carlos Giraldo
  • Jose E. Gomez-Gonzalez
  • Jorge M. Uribe

Abstract

We use a combination of Extreme Gradient Boosting and SHAP Additive Explanations to uncover the determinants of sovereign risk across a wide range of countries from 2002 to 2021. By considering numerous variables established in existing literature within a single framework, we identify year-by-year determinants of sovereign credit risk. To gauge the liquidity and solvency aspects of sovereign risk, we utilize 5- and 10-year yield spreads as proxies. Our findings show that the key variables driving sovereign risk have remained relatively stable over time and exhibit similarities in both liquidity and solvency components. Among the prominent variables, various macroeconomic fundamentals play a crucial role, including the current account, GDP growth, per capita GDP growth, and the real exchange rate. Prior to the Global Financial Crisis, macroeconomic variables, particularly the current account, held the highest importance in explaining sovereign risk. However, following the GFC, the relative importance of these variables diminished, giving way to institutional variables, especially the rule of law.

Suggested Citation

  • Iader Giraldo & Carlos Giraldo & Jose E. Gomez-Gonzalez & Jorge M. Uribe, 2023. "An Explained Extreme Gradient Boosting Approach for Identifying the Time-Varying Determinants of Sovereign Risk," Documentos de trabajo 20789, FLAR.
    • Handle: RePEc:col:000566:020789
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    References listed on IDEAS

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    1. Francis A. Longstaff & Jun Pan & Lasse H. Pedersen & Kenneth J. Singleton, 2011. "How Sovereign Is Sovereign Credit Risk?," American Economic Journal: Macroeconomics, American Economic Association, vol. 3(2), pages 75-103, April.
    2. Montes, Gabriel Caldas & Nicolay, Rodolfo & Pereira, Flavio, 2022. "Does fiscal sentiment matter for sovereign risk?," The Quarterly Review of Economics and Finance, Elsevier, vol. 86(C), pages 18-30.
    3. Ordoñez-Callamand, Daniel & Gomez-Gonzalez, Jose Eduardo & Melo-Velandia, Luis Fernando, 2017. "Sovereign default risk in OECD countries: Do global factors matter?," The North American Journal of Economics and Finance, Elsevier, vol. 42(C), pages 629-639.
    4. Mr. Fabio Comelli, 2012. "Emerging Market Sovereign Bond Spreads: Estimation and Back-testing," IMF Working Papers 2012/212, International Monetary Fund.
    5. Andrade, Sandro C. & Ekponon, Adelphe & Jeanneret, Alexandre, 2023. "Sovereign risk premia and global macroeconomic conditions," Journal of Financial Economics, Elsevier, vol. 147(1), pages 172-197.
    6. Francis A. Longstaff & Sanjay Mithal & Eric Neis, 2005. "Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit Default Swap Market," Journal of Finance, American Finance Association, vol. 60(5), pages 2213-2253, October.
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    8. Eichler, Stefan & Maltritz, Dominik, 2013. "The term structure of sovereign default risk in EMU member countries and its determinants," Journal of Banking & Finance, Elsevier, vol. 37(6), pages 1810-1816.
    9. Jens Hilscher & Yves Nosbusch, 2010. "Determinants of Sovereign Risk: Macroeconomic Fundamentals and the Pricing of Sovereign Debt," Review of Finance, European Finance Association, vol. 14(2), pages 235-262.
    10. Gomez-Gonzalez, Jose E. & Uribe, Jorge M. & Valencia, Oscar M., 2023. "Does economic complexity reduce the probability of a fiscal crisis?," World Development, Elsevier, vol. 168(C).
    11. Comelli, Fabio, 2012. "Emerging market sovereign bond spreads: Estimation and back-testing," Emerging Markets Review, Elsevier, vol. 13(4), pages 598-625.
    12. Thuraisamy, Kannan S. & Gannon, Gerard L. & Batten, Jonathan A., 2008. "The credit spread dynamics of Latin American euro issues in international bond markets," Journal of Multinational Financial Management, Elsevier, vol. 18(4), pages 328-345, October.
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    Cited by:

    1. Jose E. Gomez-Gonzalez & Jorge M. Uribe & Oscar M. Valencia, 2023. "Sovereign Risk and Economic Complexity: Machine Learning Insights on Causality and Prediction," IREA Working Papers 202315, University of Barcelona, Research Institute of Applied Economics, revised Nov 2023.
    2. Gomez-Gonzalez, Jose E. & Uribe, Jorge M. & Valencia, Oscar, 2024. "Sovereign Risk and Economic Complexity," IDB Publications (Working Papers) 13393, Inter-American Development Bank.

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    More about this item

    Keywords

    Sovereign risk; Explainable AI; Extreme Gradient Boosting model; Macroeconomic and institutional factors.;
    All these keywords.

    JEL classification:

    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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