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Political Risk and Firm Default Probability: Exploring export credits to high-risk countries

by Annika Sandström of the Swedish School of Economics and Business Administration

August 2006

Abstract: Despite the increased presence and importance of political risk in the world economy, this subcategory of country risk has not been well explored in the credit risk literature involving private firms. In this study, we investigate political and legal country risk determinants of firm default probabilities in 88 countries, using a dynamic logit specification to a new dataset of export credit contracts from Finland. We model default probabilities for private firms in countries with different perceived risk levels and country legal origins. We condition the firm default probabilities on a vector of country specific political and legal risk variables, including government and instability risks, the level of democracy as well as legal and creditor rights. We also control for the usually employed traditional firm specific financial variables for a group of companies from 14 countries, defined as the largest high risk export countries of Finland. Our preliminary results indicate that information on political instability, especially in the form of external conflict in a host country may constitute a significant predictor for firm default, that may not otherwise be detected with scarcely available, or unreliable accounting information.

Keywords: Default probability, Company Failure Risk, Export credit, Political Risk.

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