Assessing sovereign default risk: A bottom-up approach

Feng Liu*, Egon Kalotay, Stefan Trück

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

4 Citations (Scopus)


This study assesses sovereign default risk of individual U.S. states utilizing information about default risk at the company level. We link integrated risk factors of the private sector to the overall sovereign risk of state governments in conjunction with additional financial variables. Using data on Moody's KMV expected default frequencies (EDFs) on corporate default risk, we derive credit risk indicators for different industries. Building on these measures, we then develop state level credit risk indicators encompassing industry compositions to explain the behaviour of credit default swap (CDS) spreads for individual states. We find that market-based measures of private sector credit risk are strongly associated with subsequent shifts in sovereign credit risk premiums, as measured by CDS spreads. The developed credit risk indicators are highly significant in forecasting sovereign CDS spreads at weekly and monthly sampling frequencies. Overall, our findings suggest a strong predictive link between market expectations of private sector credit quality and expectations of sovereign credit quality - a connection that is not directly discernible from scoring models.

Original languageEnglish
Pages (from-to)525-542
Number of pages18
JournalEconomic Modelling
Publication statusPublished - Apr 2018


  • CDS spreads
  • Default risk
  • Expected default frequencies (EDFs)
  • Sovereign credit risk


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