Sovereign Default Risk in the Euro Zone - Dissertation Example

Download file to see previous pages The resulting models which were arrived at using the forward stepwise procedure passed various goodness-of-fit tests as well as other tests of the significance of coefficients. This indicates that both CDS spread and Debt/GDP ratio improved the model’s predictive power in the case of the Eurozone while CDS spread was the only significant factor for Cyprus. Tests of the model using in-sample and out-of-sample data show that it is capable of predicting default and non-default with a high degree of accuracy.

1.0 Introduction
Sovereign default has been present in world economies throughout history. One of the countries that have defaulted in the past is Argentina. Very often, it is the same set of countries that are habitually in this state of economic crisis. The 2008 financial crisis has been described as one of the worst to be felt in this modern age since the Great Depression of 1933 (Your reference here). Its effects are still underway and countries around the world are trying their utmost to maintain financial stability. One of the newest currency unions and the most powerful in the world; the Euro-Zone, therefore makes an interesting study.

One of the single most important events that preceded the spiraling downturn in the 2008 financial crisis is the Lehman Brothers' failure on September 15, 2008. Prior to the 2008 financial crisis, the sovereign Credit Default Swap (CDS) market was not as significant as corporate CDS markets. This was due to the relatively stable outlook of developed nations within the Euro Block and the perceived minimal default risk associated with these countries. As a result of the Lehman Collapse, and other proceeding financial institutional failures, large losses worldwide were incurred, which had spillover effects eventually affecting entire economies. This resulted in negative implications for investor confidence and a reduction of credit in the market.

The bailouts for these banks by the individual governments could only be made possible by incurring massive amounts of debt (Dieckmann and Plank 2011). This led Governments to increase the risk of sovereign default and a global reassessment of credit risk. In turn, CDS in the sovereign market became highly liquid as the uncertainty of these nations became an issue, implying an increase in sovereign credit risk.

Since 2012 the Eurozone has been characterized by deepening crises in several countries, some of which have suffered what is described as a selective default. These crises have been characterized by increases in CDS spread, increased Debt/GDP ratio, and high bond yields. This has led to credit rating agencies such as Moody’s and Standard and Poor’s giving ratings to some of these countries that indicate to investors the risks associated with government bonds. In addition to Cyprus and Greece, some of the countries that have received speculative ratings include Bulgaria, Hungary, Italy, Ireland, Latvia, Estonia, Portugal, and Spain (Bloomberg 2013). Concerns have been raised that the ratings given by credit rating agencies are unreliable as the default ratings for Greece in 2012 and Cyprus in 2013 came after the event.

The aim of this study is to evaluate the risk of sovereign default in the Eurozone and also to develop an econometric model that is capable of predicting default before the event takes place. ...Download file to see next pages Read More