Abstract
Sovereign risk refers to the likelihood of a government defaulting on its debt obligations, a risk that is reflected in sovereign credit ratings. These ratings, assigned by agencies such as Standard and Poor’s, Moody’s, and Fitch, are influenced by various factors, including economic stability, fiscal health, the political environment, and external conditions like exposure to international financial markets. Sovereign credit ratings assess the probability of default or financial distress, thereby providing an indication of sovereign risk. A market-based measure of this risk is the cost of credit default swaps (CDS), which represent the price of insuring against default. Both credit ratings and CDS significantly impact debt repayment costs, access to international capital markets, and overall economic conditions. Consequently, sovereign credit ratings play a critical role in facilitating access to global capital markets, benefiting not only countries but also investors, policymakers, and the broader financial system.
This thesis emphasises the importance of sovereign risk across various economic and financial dimensions. It examines how sovereign ratings can influence economic growth in emerging economies, explores the spillover effects of sovereign risk on international stock markets, analyses the interconnectedness between sovereign risk, economic uncertainty, and energy-related risks, and investigates the potential impact of ESG (Environmental, Social, and Governance) risks on sovereign risk. The first empirical chapter of this thesis aims to investigate the impact of sovereign credit ratings on economic growth in emerging and developing markets by comparing the performance of rated countries with that of non-rated countries from 1995 to 2020. To achieve this, the study employs a quasi-experimental research design, specifically a difference-in-differences technique with heterogeneous treatment, to model the cross-country variability in the timing of ratings. The estimation results indicate that sovereign credit ratings have a negative effect on economic growth in emerging and developing economies. Therefore, policymakers should prioritise maintaining a low debt-to-GDP ratio to maximise the benefits of credit ratings, as a lower ratio suggests a favourable balance between debt and income.
The second empirical chapter examines the spillover effects of sovereign risk on international stock markets using a dynamic spatial Durbin model (SDM) applied to a panel of forty countries from the first quarter of 2009 to the second quarter of 2024. The findings indicate that an increase in sovereign risk, as measured by credit default swap (CDS) spreads, results in a significant decrease in both local and foreign stock prices, with an average reduction of 0.027
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percent across foreign markets. These effects are transmitted through geographical, economic, and financial channels, with exchange rates, gross fixed capital formation, and industrial production playing crucial roles in influencing stock market performance. Furthermore, the negative spillover effects from rising gross fixed capital formation and sovereign risk, alongside the positive effects from industrial production, illustrate that foreign markets are more significantly impacted than domestic ones.
The third empirical chapter employs a quantile vector autoregressive model on a dataset collected between April 2011 and July 2024 to examine the interplay among economic uncertainty, energy-related risks, and sovereign risk in BRICS economies. The empirical results indicate that these risk factors exhibit strong interconnectedness under both low- and high-risk profiles. Under a low-risk profile, energy risks act as transmitters in all countries except Russia and India. Sovereign risk experiences shocks in Brazil, India, and South Africa but transmits shocks in Russia and China. Meanwhile, economic risk serves as a shock transmitter in South Africa and India, while it plays the role of a receiver in Brazil, Russia, and China. In high-risk conditions, economic risk acts as a shock transmitter in Russia and India but receives shocks in Brazil, China, and South Africa. Sovereign risk receives shocks in all countries except China, while energy risk transmits shocks across all countries except Russia. Therefore, the dynamics of the studied risks are primarily driven by the individual heterogeneities of each country and their risk profiles, rather than their energy trade status.
The fourth empirical chapter examines the impact of ESG performance on sovereign risk by employing various methodologies, including Granger causality and dynamic common correlated effects, such as cross-sectionally Autoregressive Distributed Lag (ADL) and cross-sectionally Distributed Lag (DL) models. This analysis encompasses seventy-two countries worldwide, utilizing annual data from 2000 to 2022. The findings indicate that sovereign risk is influenced not only by country-specific factors but also by spatial correlations among countries. Furthermore, the common correlated effects analysis reveals that ESG performance consistently has a positive impact on sovereign risk in both the short and long term. The long-term positive effect is particularly evident for the ESG components, specifically the environmental and social pillars, whereas the governance pillar demonstrates a negative effect. Additionally, the causal analysis suggests that ESG risk factors can serve as predictors of sovereign risk across different countries. The potential for ESG performance to elevate sovereign risk in emerging economies underscores the trade-off between sustainability performance and sovereign solvency in these nations. These findings offer new insights into
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how global economic factors influence stock market volatility, primarily through specific transmission channels. The interconnected nature of global financial markets reinforces the necessity for coordinated international policy responses to mitigate the transmission of sovereign risk across borders, highlighting the importance of multilateral collaboration in sovereign risk mitigation. Furthermore, policymakers should integrate energy, economic, and debt management policies to promote financial and economic stability while enhancing crisis resilience. Effective debt management and investment in renewable energy serve as alternative policy instruments to strengthen creditworthiness in emerging countries. These nations should align their national ESG policies to enhance their creditworthiness, which is essential for achieving their sustainable development goals.
In summary, this thesis provides key insights into the role of sovereign risk within economic and financial systems. First, it demonstrates that sovereign ratings significantly negatively impact economic growth in emerging markets. Second, it highlights substantial spillover effects of sovereign risk on both domestic and international stock markets, indicating that changes in a country's risk profile can affect global financial stability. Third, the thesis reveals a strong interconnectedness between sovereign risk, energy risk, and economic uncertainty, with these risks amplifying one another, particularly in energy-dependent economies. Lastly, it shows that ESG factors play a crucial role in shaping sovereign risk, suggesting that stronger social and governance practices can enhance economic resilience. Collectively, these findings provide a deeper understanding of the complex and far-reaching effects of sovereign risk on global economic and financial dynamics.