The Commonality of Sovereign Credit Risk: A Rating-Based Approach

88 Pages Posted: 21 Jan 2014 Last revised: 17 Apr 2018

See all articles by Haitao Li

Haitao Li

University of Michigan - Stephen M. Ross School of Business; Cheung Kong Graduate School of Business; Cheung Kong Graduate School of Business

Tao Li

City University of Hong Kong (CityUHK) - Department of Economics & Finance

Xuewei Yang

Nanjing University - School of Management and Engineering

Date Written: March 31, 2018

Abstract

There exists strong commonality in credit risk across sovereigns [Pan and Singleton (2008); Longstaff, Pan, Pedersen and Singleton (2011)]. This paper embeds this commonality into a rating-based, reduced-form model. A parsimonious version of the rating-based model can adequately capture the commonality in sovereign credit markets and jointly fit the CDS spreads of multiple countries. The model's pricing errors are comparable to those of a one-factor model with country-by-country estimation but without resorting to unreasonable parameter estimates. Portfolio analyses suggest that the estimated rating-based model is more consistent with the dynamics of CDS spreads and thus can generate reliable density forecasts for sovereign CDS portfolios.

Keywords: Credit Rating, Sovereign Credit Risk, Credit Default Swap, Systematic Risk, Eurozone Debt Crisis, Implied Credit Rating

JEL Classification: G22, G33

Suggested Citation

Li, Haitao and Li, Tao and Yang, Xuewei, The Commonality of Sovereign Credit Risk: A Rating-Based Approach (March 31, 2018). Available at SSRN: https://ssrn.com/abstract=2381665 or http://dx.doi.org/10.2139/ssrn.2381665

Haitao Li

University of Michigan - Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States
734-615-5475 (Phone)

Cheung Kong Graduate School of Business ( email )

Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China

Cheung Kong Graduate School of Business ( email )

Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China

Tao Li (Contact Author)

City University of Hong Kong (CityUHK) - Department of Economics & Finance ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong

Xuewei Yang

Nanjing University - School of Management and Engineering ( email )

22 Hankou Road, Gulou District
Nanjing, Jiangsu 210093
China

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