Joint default probabilities and sovereign risk

The assessment of sovereign risk is of crucial importance for international lenders and investors. Many existing sovereign risk approaches are opaque and heavily rely on subjective choices. In general, they lack a theoretical basis. To assess sovereign risk, we use the Merton model in which a loan defaults if the value of a firm's assets falls below the value of its debt. In a portfolio context, this implies that default correlations warrant the utmost attention. We analyze defaults for 37 countries during the period 1970-1998. We find that sovereign default correlations are low. Joint defaults are highest in Central and Eastern Europe. They are intermediate in Latin America and they are low in (Southeast) Asia.