Abstract
The COVID-19 crisis has revealed the economic vulnerability of various countries and, thus, has instigated the systematic exploration and forecasting of sovereign default risks. Multivariate statistical and stochastic process-based sovereign default risk forecasting has a 50-year developmental history. This article describes a continuous, non-homogeneous Markov chain method as the basis for a COVID-19-related sovereign default risk forecast model. It demonstrates the estimation of sovereign probabilities of default (PDs) over a five-year horizon period with the developed model reflecting the impact of the COVID-19 crisis. The COVID-19-adopted Markov model estimates PDs for most countries, including those that are advanced with AAA and AA ratings, to suggest that no sovereign nation’s economy is secure from the financial impact of the COVID-19 pandemic. The dynamics of the estimated PDs are indicative of contemporary evidence as experienced in the recent financial crisis. The empirical results of this article have policy implications for foreign investors, sovereign lenders, export finance institutions, foreign trade experts, risk management professionals, and policymakers in the field of finance. The developed model can be used to timely recognize potential problems with sovereign entities in the current COVID-19 crisis and to take appropriate mitigating actions.
Highlights
Political, sovereign debt and financial crises have emerged in recent decades to precede the COVID-19 pandemic
With the help of a continuous Markov chain, probabilities of transitions can be estimated by exponentiating the generator matrix
To ensure time-varying flexibility so that the estimated probability of default (PD) term structure adequately reflects the crisis caused by the COVID-19 pandemic, a non-homogeneous Markov chain was developed
Summary
Sovereign debt and financial crises have emerged in recent decades to precede the COVID-19 pandemic. These crises have revealed the vulnerability of various countries around the globe and instigated the systematic exploration and forecasting of such sovereign default risks. The COVID-19 pandemic has presented novel challenges for sovereign default forecasting. Sovereign default forecasting does not differ from predicting corporate or bank failure. Since far fewer sovereign entities exist than companies or banks, there are significantly less observed data, especially those observations of default states that are available to modelers. Contributing variables of sovereign default differ substantially from those of corporate or bank failure prediction
Sign-in/Register to view highlights & summary Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a call
