In the course of this project, the Capstone team identified the need for a more precise risk forecasting methodology on the directional movements of sovereign spreads, one that quantifies and includes political risk and uncertainty in addition to sovereign ratings. To do so, a statistical model was developed to triangulate sovereign risk spread, sovereign credit ratings and political risk indices.
The Capstone team aimed to more accurately forecast the directional movements of sovereign spreads by incorporating political uncertainty in addition to ratings, through the use of statistical methods. In the conclusion of the project, the team found that political risk does correlate with sovereign spreads. Within the developed model, political risk explains between 61% to 88% of variance depending on the country. This finding is more consistent with correlation than causation, and weaknesses in the model may be related to the political risk indices utilized, ICRG. Going forward, the Capstone team believes BCG Platinion should find a more actionable and forward-looking measure of political risk that captures fluctuations at a more granular level, or find better proxy indicators for political risk that vary more over-time.