Title: Spread as a country risk's measure. Applied analysis to emerging markets.
From the second half of the seventies, in consequence of the financial integration among the different economies, the importance of estimating risks associated with the operations on international markets has increased considerably. The several financial crisis succeeded one another in the course of the twentieth century have infact produced uncertainty and mistrust among international investors. In particular, with reference to bonds issued by emerging markets, investors have shown perplexity about the real capacity of those countries to honour their international debt. In this situation, international operators have begun to feel the necessity to have efficacious instruments to measure the so-called country risk. This term represents the risk associated with those factors which affect a country's ability, or willingness, to pay its external debt, more specifically, country risk is the risk that a foreign borrower (sovereign or private) doesn't respect his international debt because of economic, political or social reasons which are internal the country. Thus country risk analysis consist mainly of a quantitative and qualitative assessment of economic, financial and socio-political variables.
Aim of the paper is to establish which of these variables (economic, financial, political, social) have a predominant role in determining the risk level of an emerging country, i.e. what are the determinants of country risk?
We use, as a country risk's measure, the sovereign spread, defined as the difference between the rate of return of a bond issued by an emerging country and the rate of return of a bond issued by an industrialized country, with same currency and same maturity. Unlike other works, where sovereign spread is considered as a function of just economic variables, we include in our regression also political and social indicators. We estimate by the method of the ordinary least squares a sample of cross section data consisting of spreads of bonds issued by 21 emerging markets during the period 1997-2006.
Results show that, although the economic fundamentals have a relevant role in determining sovereign spreads, country risk is influenced also by social and political factors, which are armed conflict's risk and crime.