Euromoney Country Risk Euromoney Country Risk Survey | Page 3

Country Risk:

In search of the next investment-grade sovereign

Predicting ratings actions
The usefulness of ECR scores in this process is telling. As Citi concludes from its detailed, statistical approach:
“ECR scores begin to reflect changes in sovereign credit quality as early as 10 months prior to agency rating
changes”, though this feature is more common where downgrades rather than upgrades are concerned for
reasons that Citi also attempts to explain.
The research, moreover, points to the improved ability of ECR score trends to better predict Fitch ratings
actions than other agencies, which “suggests that Fitch ratings actually lag those of S&P and Moody’s,
particularly for credit downgrades.”
The new model-based approach is used to demonstrate how ECR scores and default probabilities can be
usefully applied to analyze portfolio risk and relative value options for a broad cross-section of sovereign
credit default swaps.
Adjusting the weights attached to each of the economic, political and structural risk sub-factors comprising
the ECR scores can, furthermore, improve the predictive capabilities of the model, which provides default
probabilities on a more-timely basis (i.e. daily) than the lagged reaction function that the ratings agencies
tend to employ.
This detailed paper undoubtedly represents a major advancement in applying Euromoney’s Country Risk
Survey to multi-asset risk-return opportunities using existing model-based frameworks, backed up by positive
simulation results using long/short trading strategies.
Click on the image below to read the report:

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