Sovereign Risk

From Open Risk Manual

Definition

Sovereign Risk denotes the credit risk associated with financing instruments used by government, government-linked or supranational institutions.

The credit risk associated with sovereign debt concerns primarily debt issued in foreign currency (the assumption being that local currency debt can always be serviced)

Sovereign Risk is part of a cluster of risks involving sovereign entities (Country Risk)

Factors

Sovereign risk arises from a variety of underlying risk factors

  • macroeconomic development / economic growth
  • business cycles and concentration (e.g., commodity producers)
  • balance of payments (aggregate demand)
  • external asset-liability management
  • debtor government’s policies
  • global market conditions (e.g. commodity prices, risk aversion)

Issues and Challenges

  • The credit risk in sovereign debt may be difficult to analyse given the many uncertainties involved in understanding the operations and potential future paths of an entire economy. In contrast with companies and individuals there is only a small number of sovereigns, an example of Low Default Portfolios

See Also


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