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FRM Part II · FRM Exam Part II · Country Risk: Determinants, Measures, and Implications

A credit committee reviews criticisms of sovereign ratings from rating agencies. Which of the following is a recognized limitation of using agency sovereign ratings as the sole measure of country risk?

Agency sovereign ratings lag market information, changing after bond spreads or CDS have already moved, and they address default risk on government debt rather than the broader country risk faced by equity investors, so they should not be the only measure.

  1. ARatings are updated continuously with every market price change, creating excessive noise
  2. BRatings are lagging indicators that often adjust after market-implied default risk has changed, and focus on default rather than broader economic riskCorrect
  3. CRatings measure only equity market risk and ignore government debt
  4. DRatings are only published for countries that have already defaulted

Explanation

Ratings tend to be sticky and are changed after markets have already repriced, as seen in crises, and they measure default risk on government debt rather than the full economic risk to equity investors. Ratings are not continuous or limited to defaulters.

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