Value-based assessment of sovereign risk

Abstract

Purpose – The purpose of this paper is to introduce a methodology to evaluate sovereign risk. Hereby, a value-based approach using different market measures is introduced. Design/methodology/approach – This study’s approach aims to provide a value-based assessment of sovereign risk, combining market measures from government bond, credit derivatives and other markets as well as economic indicators. Findings – The study finds that the assessment of sovereign risk is only possible when using information from different markets and adjusting according to the information included in these measures. Combining both market-based and economic information leads to a value-based evaluation of sovereign risk. Practical implications – The practical implications are given for any institution with sovereign risk on their asset side. In fact, part of this research was done for the German Actuarial Foundation which uses the recommendations of this paper for the insurance industry. Originality/value – The study’s approach is novel because it is the first to include several market-based and economic measures of a sovereign and combines it into a value-based assessment.