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Incorporating creditors' seniority into contingent claim models:Application to peripheral euro area countries

Marta Gómez-Puig (), Simon Sosvilla-Rivero () and Manish Singh ()
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Marta Gómez-Puig: Risckcenter Research group–IREA. Av. Diagonal 696; 08034 Barcelona ,Spain
Manish Singh: Risckcenter Research group–IREA. Av. Diagonal 696; 08034 Barcelona ,Spain

No 201803, IREA Working Papers from University of Barcelona, Research Institute of Applied Economics

Abstract: This paper highlights the role of multilateral creditors (i.e., the ECB, IMF, ESM etc.) and their preferred creditor status in explaining the sovereign default risk of peripheral euro area (EA) countries. Incorporating lessons from sovereign debt crises in general, and from the Greek debt restructuring in particular, we define the priority structure of sovereigns' creditors that is most relevant for peripheral EA countries in severe crisis episodes. This new priority structure of creditors, together with the contingent claims methodology, is then used to derive a set of sovereign credit risk indicators. In particular, the sovereign distance-to-default indicator, proposed in this paper (which includes both accounting metrics and market-based measures) aims to isolate sovereign credit risk by using information from the public sector balance sheets to build it up. Analyzing and comparing it with traditional market-based measures of sovereign risk suggests that the measurement and predictive ability of credit risk measures can be vastly improved if we account for the changing composition of sovereigns' balance sheet risk based on creditors' seniority.

Keywords: Sovereign default risk; peripheral euro area countries; contingent claims; distance-to-default. JEL classification:E62; H3; C11. (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban and nep-eec
Date: 2018-02, Revised 2018-02
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