Modelling Ratings Effects in Country Risk

Country risk has recently become a topic of major c ncern for the international financial community. A critical assessment of country risk is es ential because it reflects the ability and will ingness of a country to service its financial obligations. Vario us risk rating agencies employ different methods to determine country risk ratings, combining a range o f qualitative and quantitative information regardin g alternative measures of economic, financial and pol itical risk into associated composite risk ratings. This paper provides an international comparison of count ry risk ratings compiled by the International Count ry Risk Guide (ICRG), which is the only international ratin g agency to provide detailed and consistent monthly data over an extended period for a large number of count ries. As risk ratings can be treated as indexes, th ir rate of change, or returns, merits attention in the same ma nner as financial returns. For this reason, a const ant correlation multivariate asymmetric ARMA-GARCH mode l is estimated and tested. The empirical results provide a comparative assessment of the conditional means and volatilities associated with internation al country risk returns across countries and over time , highlight the importance of economic, financial a nd political risk ratings as components of a composite risk rating, evaluate the multivariate effects of alternative risk returns, and evaluate the usefulness of the IC RG risk ratings in modelling risk returns.