Last updated: April 2008 Volume 55, Number 1 |
Measuring and Analyzing Sovereign Risk with Contingent Claims
Michael Gapen, Dale Gray, Cheng Hoon Lim, and Yingbin XiaoFull Text of this Article (PDF 432Kb)
Abstract: This paper develops a comprehensive new framework to measure and analyze sovereign risk. Contingent claims analysis is used to construct a marked-to-market balance sheet for the sovereign and derive a set of forward-looking credit risk indicators that serve as a barometer of sovereign risk. Applications to 12 emerging market economies show the approach to be robust, and the risk indicators are a significant improvement over traditional macroeconomic vulnerability indicators and accounting-based measures. The framework can help policymakers design risk mitigation strategies and rank policy options using a calibrated structural model unique to each economy. [JEL E61, G13,G15, H63]