Current Drivers of Sovereign Risk

In a follow up to yesterday’s post, here is an analysis of what is currently driving sovereign risk.

Net liabilities as a percent of GDP have a relationship with current CDS spreads.

The 2010 OECD projected government fiscal balance also has a relationship with current sovereign CDS spreads.

The current account deficit also matters, as countries with current accounts deficits are less likely to be net savers and an investor would be more worried about getting their money back from a country that doesn’t have money coming in each year:

In all of these charts, the larger countries such as the US, Germany, Japan and France have lower spreads than smaller countries with similar statistics.  So in a simple linear regression I included:

  1. The log of a country’s 2009 GDP
  2. The 2009 current account balance as a percent of GDP
  3. The government’s 2010 projected net liabilities

With the dependant variable being the current CDS spreads. I didn’t use the fiscal balance factor because it is too correlated with the other explanatory variables. The results are in the chart below.

The relationship is even cleaner if the net liabilities variable is set to zero when the variable is negative.

While there are other factors that are mentioned in the headlines everyday that are also driving these CDS prices, it is interesting how a few variables can neatly explain the market’s current view of sovereign risk.