Sovereign Debt Ratings: A Judgmental Model Based on the Analytic Hierarchy Process

Abstract

The major rating agencies assign quality rating to international security offerings. These ratings serve as indicators of perceived sovereign risk associated with such offerings. A review of the ratings process followed by the major rating agencies (in particular, the Standard & Poor's Corporation) reveals that ratings are assigned with considerable reliance on informal judgment. Informal judgmental systems, however, can induce serious inconsistencies in the relative importance assigned to criteria used in assigning rating and lead to biased ratings.

This paper presents a formal judgmental model for assigning sovereign debt ratings that avoids the potential inconsistencies of informal systems. Model use is illustrated by relying on descriptions of the ratings process published by Standard and Poor’s Corporation. While the model proposed in this paper provides a framework for the rating agencies to ensure consistency in their ratings process, we suggest a complementary relationship between multivariate statistical classification models typically used to assess economic and political risk and the proposed model which assigns country risk ratings.