Forecasting sovereign default using panel models: A comparative analysis (original) (raw)
2010
This paper uses model averaging techniques to identify robust predictors of sovereign default episodes on a pooled database for 46 emerging economies over the period 1980-2004. Sovereign default episodes are defined according to Standard & Poor s or by non-concessional International Monetary Fund loans in excess of 100 percent of the country s quota. The authors find that, in addition to the level of indebtedness, the quality of policies and institutions is the best predictor of default episodes in emerging market countries with relatively low levels of external debt. For emerging market countries with a higher level of debt, macroeconomic stability plays a robust role in explaining differences in default probabilities. The paper provides evidence that model averaging can improve out-of-sample prediction of sovereign defaults, and draws policy conclusions for the current crisis based on the results.
Early warning systems for sovereign debt crises: The role of heterogeneity
Computational statistics & data analysis (2006) 51, 1420-1441
Sovereign default models that differ in their treatment of unobservable country, regional and time heterogeneities are systematically compared. The analysis is based on annual data over the 1983–2002 period for 96 developing economies. Inference-based criteria and parameter plausibility overwhelmingly favour more complex models that allow the link between the probability response and the fundamentals to vary over time and across countries. However, out-of-sample forecast evaluation using several loss functions and equal-predictive-ability tests suggests that simplicity beats complexity. Parsimonious pooled logit models produce the most accurate sovereign default forecasts and outperform the naive benchmarks.
A Note on Causality between Debt and Sovereign Credit Ratings using Panel Tests
2011
This paper uses linear and nonlinear panel causality tests to empirically explore the direction of causality between external debt stocks and credit ratings for a group of developing countries over the period 1998 to 2008. The results indicate that for the vast majority of the countries in the panel, a bi-directional causal relationship between external debt and sovereign ratings is
Fitting and Forecasting Sovereign Defaults Using Multiple Risk Signals
Social Science Research Network, 2011
In this article, we try to realize the best compromise between in-sample goodness of fit and out-of-sample predictability of sovereign defaults. To do this, we use a new regressiontree based approach that signals impending sovereign debt crises whenever pre-selected indicators exceed specific thresholds. Using data from emerging markets and Greece, Ireland, Portugal and Spain (GIPS) over the period 1975-2010, we show that our model significantly outperforms existing competing approaches (logit, stepwise logit, noiseto-signal ratio and regression trees), while balancing in-and out-of-sample performance. Our results indicate that illiquidity (high short-term debt to reserves) and default history, together with real GDP growth and US interest rates, are the main determinants of both emerging market country defaults and the recent European sovereign debt crisis.
Predicting sovereign debt crises: An Early Warning System approach
Journal of Financial Stability, 2017
In light of the renewed challenge to construct effective "Early Warning Systems" for sovereign debt crises, we empirically evaluate the predictive power of econometric models developed so far across developed and emerging country regions. We propose a different specification of the crisis variable that allows for the prediction of new crisis onsets as well as duration, and develop a more powerful dynamic-recursive forecasting technique to generate more accurate out-of-sample warning signals of sovereign debt crises. Our results are shown to be more accurate compared to the ones found in the existing literature.
The determinants of sovereign default: A sensitivity analysis
International Review of Economics & Finance, 2014
A vast and growing empirical literature aims at identifying key determinants of sovereign default. The literature is extensive and controversial. Can policy-makers use this body of research to learn anything that can help reduce the likelihood of sovereign default? We use a variant of Extreme Bound Analysis (EBA) to examine if any of the conclusions from the existing studies on the determinants of sovereign default is robust to small changes in the conditioning information set. Our EBA, spanning 190 countries over 1970-2010, upholds the robustness of the observed association between sovereign default and credit worthiness, growth, leverage on export earnings, debt service ratio, reserves, inflation, exchange rate, trade deficit, corruption, and democratic accountability. At the same time, our EBA reveals that the correlations between sovereign default and several of the controversial variables (namely, openness, central bank liabilities, interest payments, cost of borrowing, imports, exports, per capita GNP, and government stability) are highly sensitive to small alterations in the conditioning information set.
Predicting Sovereign Debt Crises
IMF Working Papers, 2003
The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. We develop an early-warning model of sovereign debt crises. A country is defined to be in a debt crisis if it is classified as being in default by Standard & Poor's, or if it has access to nonconcessional IMF financing in excess of 100 percent of quota. By means of logit and binary recursive tree analysis, we identify macroeconomic variables reflecting solvency and liquidity factors that predict a debt-crisis episode one year in advance. The logit model predicts 74 percent of all crises entries while sending few false alarms, and the recursive tree 89 percent while sending more false alarms.
The elusive costs of sovereign defaults
Journal of Development Economics, 2011
Few would dispute that sovereign defaults entail significant economic costs, including, most notably, important output losses. However, most of the evidence supporting this conventional wisdom, based on annual observations, suffers from serious measurement and identification problems. To address these drawbacks, we examine the impact of default on growth by looking at quarterly data for emerging economies. We find that, contrary to what is typically assumed, output contractions precede defaults. Moreover, we find that the trough of the contraction coincides with the quarter of default, and that output starts to grow thereafter, indicating that default episode seems to mark the beginning of the economic recovery rather than a further decline. This suggests that, whatever negative effects a default may have on output, those effects result from anticipation of a default rather than the default itself. * We would like to thank Eduardo Cavallo and other participants in the December 2005 IPES pre-conference, and we wish to thank Mariano Alvarez for excellent research assistance. The views expressed in this paper are the authors' and do not necessarily reflect those of the Inter-American Development Bank.
Relationship between Stock and the Sovereign CDS markets: A panel VAR based analysis
South Asian Journal of Management Sciences
This study explores the relationship between the Stock and the Sovereign Credit Default Swaps (SCDS) markets by using dataset of 36 countries.We apply Panel Vector Autoregressive (PVAR) model to gauge the impact of one market's shocks to the other. Our results decipher that changes in stock market returns explain the significant portion of the SCDS market spreads' changes. Furthermore, the magnitude of this explanation is linked with the volatility of the SCDS market. These analyses indicate that the firsthand information about the country's sovereign credit risk is contained in the respective stock market, and can be used by participants/investors to predict the SCDS market spreads.
F Determinants of sovereign bond yields in emerging economies : Some panel inferences Sri
2016
In the backdrop of international financial crisis, debt markets across the globe became highly volatile, highly contagious and posed a high risk to advanced as well as emerging economies. In this regard, the study tries to identify the proximate determinants of sovereign bond yields in emerging economies from 1980 to 2013. The empirical results of Pedroni panel cointegration tests and dynamic ordinary least squares tests show that the factors like exchange rate, federal reserve rate, oil price, US bond yield, gold price and real interest rate are the proximate determinants of the emerging economies' bond yields.
Sovereign Debt: A Quantitative Comparative Investigation of the Partial Default Mechanismú
2019
We quantitatively explore the implications of the partial default mechanism for the dynamics of sovereign debt and default in a small open economy. The model features endogenous partial default and preemptive recovery on the defaulted amount with direct utility cost of default, instead of the exclusion from international financial markets. The model is calibrated to Argentina and compared to the traditional full default models. We show that with our partial default framework, (1) the model with endowment not only matches the mean spread on debt and the debt-to-output ratio, like the traditional models, but also matches both the default frequency and the default rate; (2) the model with production, with investment as another margin to smooth consumption, improves the fit with data for the volatilities of consumption and spread on debt as well as the debt service-to-output ratio (without significant change in other moments), partially o setting the weak performance of the endowment mo...
Emerging Markets Bond Index Performance and Sovereign Default: The Case of Ecuador
2024
Further to section 8 of the above license, any mediation relating to disputes arising under such license shall be conducted in accordance with the WIPO Mediation Rules. Any dispute related to the use of the works of the IDB that cannot be settled amicably shall be submitted to arbitration pursuant to the United Nations Commission on International Trade Law (UNCITRAL) rules. The use of the IDB's name for any purpose other than for attribution, and the use of IDB's logo shall be subject to a separate written license agreement between the IDB and the user and is not authorized as part of this license. Note that the URL link includes terms and conditions that are an integral part of this license. The opinions expressed in this work are those of the authors and do not necessarily reflect the views of the Inter-American Development Bank, its Board of Directors, or the countries they represent.
A cautious note on the use of panel models to predict financial crises
Economics Letters, 2008
Panel data framework has often been used to build Early Warning Systems for financial crises. This paper questions the implicit assumption that crises are homogenously caused by identical factors. It suggests a preliminary step aiming at forming optimal country clusters.
Debt arrears as a signal of sovereign defaults
The Journal of Developing Areas, 2016
The accuracy of the inference about the risk of default is very important to the potential creditors in their lending decisions. In the literature, the usual used indicators of sovereign default in a given country (debtor) are either a rescheduling agreement between the debtor and the creditor or the presence of a credit from the International Monetary Fund (IMF). The purpose of this note is to investigate an alternative indicator of a sovereign default that precedes the default itself, and thus could be seen as an early warning signal for policymakers. In this note, debtor countries are considered "defaulted" on sovereign debt if they have a debt rescheduling agreement with at least one creditor. To address our research question, a panel dataset running from 1970 to 2010 and spanning 186 countries with at least one year of debt accumulation is used. First a Panel Probit model is estimated including all the variables along with the lags of Arrears. Then, in order to explore the role played in countries that have defaulted; we divide the sample into countries with a history of sovereign defaults, and countries with no such history. Further, in order to explore the role played in countries that have defaulted; we divide the sample into countries with a history of sovereign defaults, and countries with no such history. If a country has at least one rescheduling agreement during the years 1970-2010 then the country is considered defaulted and it is included in the "default" subset. To be included in the "no default" subset, the country should not have had any rescheduling agreement during the aforementioned period. Our results show that debt arrears are not only a good determinant of default as argued in the literature but their lagged arrears can also be used as an early warning signal for sovereign defaults. However, the accumulation of arrears does not automatically trigger a default. Moreover, the likelihood to default rises when the failure to pay debt obligations continues overtime until the actual default occurs after the obligations in the third year are not paid. These results are very crucial to both debtors and creditors. Arrears, consequently, could be used as an inducement for debtors to take preemptive actions to minimize exposure to sovereign default risk. However, even in the case of default, observing arrears will provide ample time for policy makers in debtor countries to take necessary precautionary measures.
Pricing of Sovereign Credit Risk: Evidence from Advanced Economies during the Financial Crisis
International Finance, 2013
We investigate the pricing of sovereign credit risk over the period 2008-2010 for selected advanced economies by examining two widely-used indicators: sovereign credit default swap (CDS) and relative asset swap (RAS) spreads. Cointegration analysis suggests the existence of an imperfect market arbitrage relationship between the cash (RAS) and the derivatives (CDS) markets, with price discovery taking place in the latter. Likewise, panel regressions aimed at uncovering the fundamental drivers of the two indicators show that the CDS market, although less liquid, has provided a better signal for sovereign credit risk during the period of the recent financial crisis.
The impacts of financial crisis on sovereign credit risk analysis in Asia and Europe
International Journal of Financial Engineering, 2015
In this paper, we investigate the nature of sovereign credit risk for selected Asian and European countries based on a set of sovereign CDS data over an eight-year period that includes the episode of the 2007–2008 global financial crisis. Our results indicate that there exists strong commonality in sovereign credit risk among the countries studied in this paper following the crisis. In addition, our results also show that commonality is importantly associated with both local and global financial and economic variables. However, there are markedly different impacts of the sovereign of credit risk in Asian and European countries. Specifically, we find that foreign reserve, global stock market, and volatility risk premium, affect Asian and European sovereign credit risks in the opposite direction. Lastly, we model the arrival rates of credit events as a square-root diffusion process from which a pricing model is constructed and estimated over pre- and post-crisis periods. Then the resu...
How Costly is Sovereign Default? Evidence from Financial Markets
SSRN Electronic Journal, 2011
We use stock market data to test cross-sectional implications of theories of sovereign default and provide a market-based estimate of sovereign default costs. We find that the stock prices of firms vulnerable to financial intermediation disruption, or firms more exposed to the government, are particularly sensitive to changes in sovereign credit spreads. This is consistent with theories in which default is costly because it disrupts financial intermediation and damages government reputation. Estimation of a structural valuation model indicates that the market prices stocks as if sovereign default has large effects on vulnerable stocks, translating to a 12% destruction of the value of their productive assets. (JEL G12, G15, G01, F34)
An Empirical Analysis of Sovereign Credit Risk Co-movement between Japan and ASEAN Countries
Journal of Economics and Behavioral Studies
Japan is the most developed economy in Asia. However, it has been on record for being the most heavily indebted country among OECD countries. In many circumstances, the high sovereign debt level indicates a high possibility of sovereign credit risks associated with investment in government bond. The high sovereign credit risk may also generate a number of negative externalities for private businesses operating in the host country. This paper investigates whether sovereign credit risk of Japan as measured by its sovereign credit default swap (SCDS) can better predict and commove with sovereign credit risk of selected ASEAN countries. The bivariate VAR model was used to test for Granger Causalities among these countries SCDS premiums and correlation analysis to investigate co-movements between SCDS of these countries. The results indicate that Japan’s sovereign credit risks do not co-move with those of ASEAN countries, Furthermore, Sovereign credit risks of ASEAN countries tend to l...