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date: 26 November 2020

Abstract and Keywords

This chapter describes a novel, bottom-up approach for assessing the default risk of both sovereign governments and corporate issuers. Known as Z-Metrics™, the method is practical and effective for estimating sovereign risk. A logical extension of the Altman Z-Score technique that was introduced in 1968, Z-Metrics emphasizes the financial condition, profitability, and solvency of a nation’s private sector, including banks and nonfinancial firms. The chapter first considers financial crises to provide some historical perspective before reviewing the academic and practitioner literature on sovereign risk, particularly those studies that test the predictability of sovereign defaults and crises. It then introduces the Z-Metrics system for estimating the probability of default for individual (nonfinancial) companies and evaluates the effectiveness of calculating the median and 75th percentile company five-year probability of default of the sovereign’s nonfinancial corporate sector.

Keywords: banks, default risk, financial condition, nonfinancial firms, private sector, profitability, solvency, sovereign defaults, sovereign risk, Z-Metrics

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