Joint default probabilities and country risk

The assessment of country risk is of crucial importance for both developing countries and
international lenders and investors. Many existing country risk approaches are opaque and
heavily rely on subjective choices. In general, they lack a theoretical basis. To assess country
risk, we use the Merton model in which a loan defaults if the value of a firm’s assets falls
below the amount due to the loan. In a portfolio context, this implies that default correlations
warrant the utmost attention. We find that country default correlations are significant and low.
Furthermore, joint defaults tend to be clustered in Latin American and Eastern European
transition countries, but not in Asia.

	03e41.pdf

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