Joint default probabilities and country risk

Bert Scholtens and Daphne Hameeteman
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Daphne Hameeteman: Groningen University

No 03E41, Research Report from University of Groningen, Research Institute SOM (Systems, Organisations and Management)

Abstract: The assessment of country risk is of crucial importance for both developing countries and international lenders and investors. Many existing country risk approaches are opaque and heavily rely on subjective choices. In general, they lack a theoretical basis. To assess country risk, we use the Merton model in which a loan defaults if the value of a firm’s assets falls below the amount due to the loan. In a portfolio context, this implies that default correlations warrant the utmost attention. We find that country default correlations are significant and low. Furthermore, joint defaults tend to be clustered in Latin American and Eastern European transition countries, but not in Asia.

Date: 2003
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