Sovereign Credit Risk – A Special Issue in the Journal of Risk Finance

Guest Editors:
Johann-Matthias Graf von der Schulenburg (Institute for Risk and Insurance, Gottfried Wilhelm Leibniz University Hannover, Otto-Brenner-Straße 1, 30159 Hannover, Germany)
Christoph Wegener (IPAG Business School, 184 Boulevard Saint-Germain, 75006 Paris, France, and Center for Risk and Insurance, Otto-Brenner-Straße 1, 30159 Hannover, Germany)

Examining the government bonds issued by developed nations, sovereign credit risk was more or less almost ignored until recently. Meanwhile, it has become of some importance for financial markets. The Greek government debt crisis clearly plays an important role in this context. In fact, investors now know for certain that government bonds issued by industrialized European countries are not free of default risk. Moreover, the crisis also caused fears about a possible breakdown of the currency union in Europe. The concerns about the uncertain future of the Euro led to redenomination risk (see, for example, Battistini, Pagano, and Simonelli, 2014; Basse, 2014). The sudden emergence of this very special type for foreign exchange rate risk also had effects on interest rates by considerably increasing the risk premia. As a matter of fact, some member countries of the European Monetary Union had to pay in order to make investors buy their bonds. Bagnai, Granville, and Ospina (2017), for example, have simulated the effects of the withdrawal of Italy from the common currency and have endogenised the sovereign spread dynamics.

In any case, government bond yields – which in the “good old days” before the crisis were considered to be more or less the best proxy for the risk free rate – obviously are of high importance for financial markets. Thus, the current discussions about sovereign credit risk and redenomination risk clearly do not only matter for financial risk managers. From the perspective of corporate finance theory one might, for example, ask what sovereign credit risk could mean with regard to the proxies for the risk free rate used to discount future cash flows. Financial economists might be more interested in the consequences of sovereign credit risk for the sustainability of government budget deficits. Moreover, in the field of insurance economics, it could be asked whether all long-term government bonds issued by industrialized countries still are secure investment opportunities for life insurance companies. As a matter of fact, there are a lot of relevant and interesting questions to be asked. This special issue of the Journal of Risk Finance tries to address at least some of these important issues.

This special issue is structured as follows: The study by Hu shows that positive sovereign rating events do not lead to significant bank stock price reactions, while negative events are associated with negative share price effects on domestic banks. The following paper by Gruppe, Basse, Friedrich, and Lange reviews the literature on interest rate convergence and the European debt crisis with a special focus on the current fiscal problems of some governments in Europe. The third paper by Rjiba, Ben Slimane, and Bellalah analyses the impact of the global financial crisis on the conditional beta in the region of North America and Western Europe and the effect on the behavior and decisions of the investor. The next paper by Rodriguez Gonzalez, Kunze, Schwarzbach, and Dieng investigates the long term relationships of long term EMU government bond yields. From an asset managers' or risk managers' perspective during the Euro Crisis the relevance of sovereign credit and redenomination risk became a major issue. Furthermore, the authors find empirical evidence, that it has to be differentiated between core and non-core EMU member countries. Rashid, Ahmad, and Yasmin examine the long- and short-run relationship between macroeconomic indicators (exchange rates, interest rates, exports, imports, foreign reserves, and the rate of inflation) and Sovereign Credit Default Swap (SCDS) spreads for Pakistan. The following study by Guesmi, Trad, Rachdi, and Hakimi aims to focus on the main determinants of the performance and stability-banking sector in the Middle East and North Africa (MENA) region during the global financial crisis. Gubareva and Borges develop the historical derivative-based Value at Risk for assessing the downside risk of a sovereign debt portfolio through the integrated treatment of interest rate and credit risks. The CDS spreads and the fixed-leg rates of IRS are used as proxies for credit risk and interest rate risk, respectively.

Bagnai, A., Granville, B., & Ospina, C. A. M. (2017). Withdrawal of Italy from the euro area: Stochastic simulations of a structural macroeconometric model. Economic Modelling 64, 524 – 539. 
Basse, T., (2014). Searching for the EMU core member countries. European Journal of Political Economy 34, S32-S39. 
Battistini, N., Pagano, M., & Simonelli, S. (2014). Systemic risk, sovereign yields and bank exposures in the euro crisis. Economic Policy 29, 203-251.

Please visit the Emerald Insight platform to access the special issue's papers.