Hot Off the Press: News-implied Sovereign Default Risk
70 Pages Posted: 18 Nov 2021 Last revised: 13 Jul 2023
Date Written: October 18, 2021
Abstract
We develop a novel sovereign default risk index using natural language processing techniques and 10 million news articles covering over 100 countries. The index is a reliable high-frequency measure of countries' default risks, particularly those lacking market-based measures. It predicts sovereign CDS spread, credit rating downgrades, and realized defaults over long horizons. Consistent with theories on sovereign risk spillovers, increase in the index predicts (i) higher firm default probability, (ii) higher firm default protection cost, and (iii) lower equity valuation, which is much stronger for global vs. country-specific default concerns. The index yields valuable signals for equity market timing strategies.
Keywords: Sovereign default, Credit risk, Equity returns, Machine learning, Natural language processing, Early warning indicators
JEL Classification: F10, F30, G12, G15
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