Sovereign Credit Risk Analysis for Selected Asian and European Countries

Abstract

We analyze the nature of sovereign credit risk for selected Asian and European countries through a set of sovereign CDS data for an eighty-year period that includes the episode of the 2008-2009 financial crisis. Our principal component analysis results suggest that there is strong commonality in sovereign credit risk across countries after the crisis. The regression tests show that the commonality is linked to both local and global financial and economic variables. Besides, we also notice intriguing differences in the sovereign credit risk behavior of Asian and European countries. Specifically, we find that some variables, including foreign reserve, global stock market, and volatility risk premium, affect the of Asian and European sovereign credit risks in the opposite direction. Further, we assume that the arrival rates of credit events follow a square-root diffusion from which we build our pricing model. The resulting model is used to decompose credit spreads into risk premium and credit-event components.