Hot Off the Press: News-implied Sovereign Default Risk

Abstract

We propose a novel high-frequency measure of sovereign default risk that can be used when traditional metrics like CDS spreads are unavailable. The measure exploits the information in news text, can be computed in real-time for any country, and is highly informative about sovereign default risk. It predicts sovereign CDS spreads, rating downgrades, and realized defaults over long horizons. Consistent with theories on sovereign risk spillovers, an increase in the index is associated with higher firm default probability, default protection cost, and lower equity valuation. The measure is valuable for equity market-timing, and its informativeness is driven by macroeconomic concerns.

Keywords: Sovereign default, Credit risk, Equity returns, News media text, Natural language processing, Early warning indicators

JEL Classification: F10, F30, G12, G15