News-Implied Sovereign Default Risk
49 Pages Posted: 18 Nov 2021
Date Written: October 18, 2021
We develop a novel real-time measure of sovereign default risk using natural language processing and implement it using 10 million news articles covering over 100 countries. Our News-implied Sovereign Risk Index (NSRI) is a high-frequency measure of countries' default risk, particularly for those lacking market-based measures: NSRI correlates with sovereign CDS spreads, predicts rating downgrades, and reflects default risk information not fully captured by CDS spreads. We assess the influence of sovereign default concerns on equity markets and find that spikes in NSRI are negatively associated with same-week market returns, which reverses over the next week, indicating that investors might overreact to default risk news. Equity markets' reaction to default concerns is more pronounced and persistent for countries with tight fiscal constraints. The reaction to global, compared to country-specific, default concerns is much stronger, underlining the relevance of global "push" factors for local asset prices.
Keywords: Sovereign default, Credit risk, Equity returns, Machine learning, Natural language processing, Early warning indicators
JEL Classification: G15, G12, F34, F37
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