Eurozone Sovereign Debt Default Risk Analysis —Based On KMV Model

It’s March 2014.The global economy could hear the steps of spring, as U.S. economy shows signs of strong recovery,and Eurozone, once stuck in the debt quagmire, is also on its way out. Economists are optimistic that recession in Eurozone will come to an end and this year will see growth in the zone for the first time in several years. However, problems are far from resolved. The chronic institutional failure implies risks of potential future crises. European debt crisis brought huge losses to all countries and peoples involved, so it’s important to save against the rainy day, thinking how to avoid future crises or reduce the loss when it’s inevitable. These are wishes and hopes of this dissertation.Earlier scholars have developed a series of macroeconomic crises models, but that’s far from enough. This dissertation, however, introduces KMV model, trying to explain the crisis in a brand new way. KMV model had formerly been used to study the credit risk of corporate debt, and had established itself as one of the most successful models in the field.But this dissertation goes further.After some major modifications while retaining its fundamentals and frames, the model isthen applied to sovereign states. That’s an experimental and unprecedented application of KMV model and is the highlight of this dissertation.After establishing the model, we first try to validate its effectiveness. It comes out that PIIGSshow higher ex-ante expected default frequency than non-PIIGS, whose ex-ante expected default frequency are close to zero. To improve the result, this dissertation also uses non-parametric estimation to fit a real distribution of guaranteed fiscal revenue, and the result is further optimized. Lastly, we do some scenario analysis on Greece and Germany using this new KMV model, and predict the safety line of government financing.At the last chapter,several proposals are presented, including the construction of early warning and prevention mechanisms,enhancing and improving EU macro-prudential regulatory framework, as well as the adjustment of welfare policy. Hope this dissertation couldbring reference and inspiration tothose people who are concerned about European debt problems.