Asset Allocation Under (One's Own) Sovereign Default Risk

Abstract

The Greek drama of the late 2000s has returned sovereign risk awareness to centre stage. The default affected a country with a relatively developed economy. It resulted in huge losses in the value of domestic assets: public debt, but also private debt, equity, real estate and furthermore pension rights and human capital. The burden has, not entirely but importantly, fallen on residents.

Should a sovereign default happen, the consequences are therefore severe for investors, not only on the sovereign’s debt, but also on all assets under the sovereign’s jurisdiction, which are contaminated by the default.

Investors should take account of sovereign default in their investment plans. The perspective of sovereign default reinforces the case for international diversification and for leaning against home bias.

There are also implications for the asset management industry: it should lean against its own home bias and provide efficient solutions for cross-border investment.

Keywords: Sovereign risk, Asset Allocation, International diversification, Home bias

JEL Classification: E62, G11