Contingent Claims Approach to Measuring and Managing Sovereign Risk

Journal of Investment Management, Vol. 5, No. 4, Fourth Quarter 2007

Posted: 17 Jan 2008

See all articles by Dale F. Gray

Dale F. Gray

International Monetary Fund (IMF); MF Risk

Zvi Bodie

Boston University - Department of Finance & Economics

Robert C. Merton

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER); Harvard Business School - Finance Unit

Abstract

This paper proposes a new approach to measure, analyze, and manage sovereign risk based on the theory and practice of modern contingent claims analysis (CCA). The paper provides a new framework for adapting the CCA model to the sovereign balance sheet in a way that can help forecast credit spreads and evaluate the impact of market risks and risks transferred rom other sectors. This new framework is useful for assessing vulnerability, policy analysis, sovereign credit risk analysis, and design of sovereign risk mitigation and control strategies. Applications for investors in three areas are discussed. First, CCA provides a new framework for valuing, investing, and trading sovereign securities, including sovereign capital structure arbitrage. Second, it provides a new framework for analysis and management of sovereign wealth funds being created by many emerging market and resource rich countries. Third, the framework provides quantitative measures of sovereign risk exposures which facilitates the design of new instruments and contracts to control or transfer sovereign risk.

Keywords: Contingent claims analysis, sovereignrisk, Merton Model, capital structure arbitrage

JEL Classification: G00

Suggested Citation

Gray, Dale F. and Bodie, Zvi and Merton, Robert C., Contingent Claims Approach to Measuring and Managing Sovereign Risk. Available at SSRN: https://ssrn.com/abstract=1084683

JOIM Editor (Contact Author)

Journal of Investment Management (JOIM) ( email )

3658 Mt. Diablo Blvd.
Suite 200
Lafayette, CA 94549
United States
925-299-7800 (Phone)
925-299-7815 (Fax)

Dale F. Gray

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

MF Risk

5921 Searl Terrace
Bethesda, MD 20816

Zvi Bodie

Boston University - Department of Finance & Economics ( email )

United States

HOME PAGE: http://www.zvibodie.com

Robert C. Merton

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

77 Massachusetts Avenue
E62-634
Cambridge, MA 02139-4307
United States
617 715 4866 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States
617-495-6678 (Phone)

Register to save articles to
your library

Register

Paper statistics

Abstract Views
1,195
PlumX Metrics