Country Sovereign Event Risk

 

Sovereign risk includes many dimensions of Risk. The result s usually called a transfer or convertibility risk since the government, under political or economic pressure, will not be able to make foreign exchange available to meet foreign currency obligations (usually through foreign exchange controls).

The Country Sovereign Event Risk is designed as a general framework to simulate how exposure to a country will evolve when this country is subject to a shock. This model applies especially well to foreign exchange control or currency devaluation, but it can apply to any event-based change.


The Country Sovereign Event Risk native to Risksvr™ includes two components:

• The probability of occurrence of this specific Event.
  This probability is taken from the Credit Default Curve that has been associated to the Country through it's Rating Rank·
  
• The Impact in percent per annum called the country revaluation/devaluation rate.
  This impact is the change in percent this event will have on the country's exposure.

Horizon	Country	Exposure	Limit	Excess
1	US	636907.004057	1000000.000000	0.000000
14	US	4194241.405910	1000000.000000	3194241.405910
30	US	4266027.320109	1000000.000000	3266027.320109
92	US	4461932.653652	1000000.000000	3461932.653652
365	US	5401307.681182	1000000.000000	4401307.681182
720	US	3017820.344407	1000000.000000	2017820.344407
Horizon	Country	Exposure	Limit	Excess
1	CN	784037.006547	100000.000000	684037.006547
14	CN	613036.449873	100000.000000	513036.449873
30	CN	605528.082043	100000.000000	505528.082043
92	CN	555606.888130	100000.000000	455606.888130
365	CN	-401373.973408	100000.000000	0.000000
720	CN	0.000000	100000.000000	0.000000

Country Sovereign Event Risk makes use of both Credit Exposure and Default Loss methodologies to quantify risk.
This is why you will need to ensure both Credit Exposures and Default Losses are configured during Country risk, even if you do not expect to compute Credit Exposures or Default Losses.

Country Exposure and Credit Exposures

For each simulation horizon and for each non-local trade in every account pertaining to the party domiciled in a country Risksvr™ computes the country exposure by applying a Growth/Contraction-Revaluation/Devaluation Rate (the impact) to the Account's Credit Exposure.(see Risksvr™ Exposure Calculations).

with: C = Country h = Horizon t = Simulation horizon G = Revaluation / Devaluation Annual Rate Party Exposure (..,C) = Counterparty Exposure (Receivables) domiciled in Country C

This exposure can be measured on an overall basis or against a predefined limit.

If you assigned a country limit,  the Excess will appear as the difference between the limit assigned and the total exposures in that country.

When a limit is defined, the Excess is displayed whenever the limit is broken.

If limits are disabled, excess is always equal to exposure.

 

Country Default Events and Credit Default Curves

To measure country sovereign event risk, the country's rating is used to read from a credit-event curve. The simulation horizon  is then used to fetch the probability of occurrence at this point in time from the daily interpolated or extrapolated probability.  see credit curves.

The Country Sovereign Event Risk framework supports two models

• The Independent model.
  This approach assumes country political and economic events are independent from external influence
• The Correlated model.
  This approach assumes country political and economic events are partly influenced by each other

The Independent Model

The likelihood of devaluation follows a "default Mode" to compute the probability of occurrence of the event described in the  Credit/Event Curve.

The independent model draws univariate random values. If the value falls within the percentile that corresponds to the occurrence of the event, a default is observed  with a loss equal to the Exposure amount computed for the country at the given time step.

Z=U[0,1]
Z ≤ P(t,Cr)
with
Z	=	Random variate drawn from a Uniform distribution between 0 and 1 i.e. 0 and 100%
C[r]	=	Country Rating Rank
t	=	simulation horizon
P(t,C[r])	=	Probability of event of rank r at time t.

The univariate framework draws a uniform random variate between 0 and 1 (i.e. 0%-100%]. If the draw falls in the default probability quantile, then a default state is observed.

If default is observed, the account exposure of the parties that are domiciled in the country under analysis are aggregated to compute statistics.

 

The Correlated Copula Model

The Multivariate model is akin to a Time-To-Default Copula, except that we use survival instead of hazards. In this respect, the country acts as the obligor and the correlation matrix between countries is identical to asset correlation.
The correlated country model generates a standardized multivariate Normal or Normal mixture Student T distribution coupled to the Credit Event curve through marginal probabilities.

From standard inverse probability densities, this methodology infers the time when the event occurs from the credit event curve.

Checking results

Once default states for each country at each time step have been computed, we can proceed to compute the default Frequency and T-statistic to check results are consistent.

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Summary:

The Country Sovereign Event model provides a general framework to measure the impact from a shock. Although initially designed to cover foreign exchange controls and Country Devaluation, it lends itself equally well to any event based scenario with an impact on Exposure.

Country Sovereign Event Risk is a byproduct of Credit Risk. As such it comes almost for free once Credit Exposures and Default Losses have been configured !