Handbook of International Banking
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Handbook of International Banking

Edited by Andrew W. Mullineux and Victor Murinde

The Handbook of International Banking provides a clearly accessible source of reference material, covering the main developments that reveal how the internationalization and globalization of banking have developed over recent decades to the present, and analyses the creation of a new global financial architecture.
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Chapter 13: Country Risk: Existing Models and New Horizons

Sarkis Joseph Khoury and Chunsheng Zhou


Sarkis Joseph Khoury and Chunsheng Zhou* 1 INTRODUCTION The meltdown in East Asia, Russia, and Latin America (partial) has compounded the concerns about systemic risk1 and country risk. The latter can exist without causing systemic failure. In fact, recent research by Khoury (2001) demonstrated that systemic risk is largely a myth, as the probability of systemic failure is practically zero under all conceivable and realistic circumstances. An extensive simulation was used to ‘prove’ the hypotheses of the model. This does not imply, however, that the country risk under discussion in this chapter does not produce limited systemic risk, reflecting itself in a burst of the asset price bubble and/or in a significant reduction of liquidity. Bordo et al. (1995) referred to this as ‘pseudo systemic risk’. This is really what most researchers refer to as systematic risk. Country risk is the likelihood of a financial loss generated by macroeconomic, political, social and/or natural disasters within a given country. It is produced by natural or by manufactured (mismanagement) factors. Country risk is focused on the value of assets (portfolio and direct investment related) held by foreign entities within the country under examination, and is broader than sovereign risk. The latter deals with the inability of a sovereign borrower to pay back its debts to foreigners. The most recent suspension of payments on Russian debt (1998) is an example of sovereign risk, as were the suspensions of payments by a large number of countries in the early 1980s. The repudiation...

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