Mapping of sovereign risks in small island economies: An application of contingent claim approach to fiji

Abstract

While a decline in the market value of sovereign assets (below a benchmark level of liabilities) can trigger sovereign distress/default risk, volatility in sovereign assets can increase the risk premium on domestic debt and credit spread on external debt. These can escalate the probability of debt default. Therefore, measuring the probability and distance to debt distress associated with sovereign positions is important for assessing the macro-financial risks of an aggregate economy. This paper presents an application of the Contingent Claim Approach (CCA) for measuring the implied asset value and its volatility for the case of Fiji. The CCA captures non-linear changes to sovereign assets and liabilities that are hardly captured by other macroeconomic variables. Our consistent empirical findings indicate no sovereign debt distress for Fiji. Unavailability of partial data on the certain composition of sovereign assets and liabilities is a limitation, but our results are consistent and useful guide to debt policy in Fiji. It is also useful for future research on debt sustainability in other similar smaller developing economies.

Keywords

• sovereign risk
• contingent claim approach
• macro-financial risk analysis
• south pacific
• fiji