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Practice paper

The shortcomings of models in country risk management

Michel-Henry Bouchet and Amaury Goguel
Journal of Risk Management in Financial Institutions, 12 (2), 125-144 (2019)
https://doi.org/10.69554/ETEL5149

Abstract

Risk management models are supposed to help anticipate and manage risks; that is, to reduce the level of uncertainty. The objective is to come up with a number of early warning signals that will awake the attention of financial analysts and fund managers. Overall, econometric models aim at simplifying the current reality to better predict the future around a limited number of scenarios. Too often, however, risk management models are based on unrealistic assumptions and assume normal probability distributions. Despite incorporating expertise and judgment to avoid any dogmatic view of models, they fall short of representing the true picture and complexity of a sovereign country with its complex legal, economic, institutional and cultural characteristics. Whatever the quality of econometric models, data sources and economic intelligence, they will never match the information and signals that domestic residents receive and accumulate daily. Country residents are embedded into an endless flow of sociopolitical, cultural, economic and financial inputs. This paper discusses a pragmatic solution to enhance the quality of risk assessment models, eg incorporating capital flight as an early warning indicator of country risk volatility. There is large evidence that in countries with weak institutions, private capital outflows and dollarisation are the by-product of a political and regulatory environment that is not conducive to dynamic and inclusive socio-economic growth.

Keywords: country risk; econometric models; ranking; ratings; volatility; crisis; capital flight

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Author's Biography

Michel-Henry Bouchet is the Distinguished Global Finance Professor at SKEMA Business School and a strategy adviser on investment funds. He has worked with BNP, the IIF and the World Bank before becoming president of Owen Stanley Financial and an adviser in debt restructuring negotiations.

Amaury Goguel is an economist and academic dean of the MSc Financial Management and Investment (FMI) programme at SKEMA Business School in Paris. He holds a PhD in economics from Lille University. He has served as consultant on global finance issues.

Citation

Bouchet, Michel-Henry and Goguel, Amaury (2019, March 1). The shortcomings of models in country risk management. In the Journal of Risk Management in Financial Institutions, Volume 12, Issue 2. https://doi.org/10.69554/ETEL5149.

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cover image, Journal of Risk Management in Financial Institutions
Journal of Risk Management in Financial Institutions
Volume 12 / Issue 2
© Henry Stewart
Publications LLP

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