The Risk of Nations
How should we look at country risk? We present the risk of nations based on a quantitative analysis1. We divide risk into market (demand) and financial components.
Looking at risk this way gives a strict definition to what is meant by risk. It is in line with Prof. Frank Knight’s observation2: Risk is a knowable probability distribution3.
As far as we know, this is the first ever quantitative analysis of country risk based on volatility.
METHOD
The analysis takes a fraction of the effort to create compared to the qualitative risk assessments seen elsewhere. The data is from TelluBase (see description at the bottom).
1.?? Country risk is measured by looking at the volatility in GDP, inflation, and exchange rates over 40 years, with more recent data being more important.
2.?? Principal Component Analysis (PCA) shows that these three factors are closely related and can be simplified into two main dimensions, capturing most of the information.
3.?? These two dimensions are called market risk (mainly affected by GDP volatility) and financial risk (mainly affected by exchange rate volatility), with inflation affecting both.
4.?? The data is processed and scaled so that the risk ranges from 0 to 100.
5.?? The results are shown in the graph. They are easier to understand because they are shown in two dimensions instead of three, making it simpler to compare countries.
Technically, the standard deviation (with a transformation to avoid right-side skew) over 40 years is used. Recent years are more heavily weighted than ancient years. This creates three risk dimensions. These three dimensions are transformed to achieve normality (boxcox).
The PCA is performed, resulting in two orthogonal dimensions, then rotated. The two dimensions capture 91% of the information content. (One dimension captures 66%.)
OBSERVATIONS
? ? The United States has the lowest risk level. The size of the economy and the dollar being the world currency creates stability.
? ? EU countries tend to have low market risk. Financial risk is higher than for the US.
? ? Australia has had stable economic growth for decades and is the least risky market.
? ? On the high-risk side, Iraq, Russia and Argentina shine. No surprise in this.
? ? China and India have moderately low risk levels. This has, and will likely continue to have, positive implications for their economies.
? ? The unnamed dots in the lower right corner are mainly Caribbean islands with currencies pegged to the U.S. dollar.
1 Qualitative assessments include political risk, corruption risk, and others. They all translate into the quantitative measure presented here.
2 Frank Knight (1921): Risk, Uncertainty and Profits
3 While uncertainty is completely non-quantifiable.
ABOUT TELLUBASE
TelluBase is the essential external database for every company and organization in need of granular global data beyond country-level averages.
It is the only database in the world that categorizes consumer groups by income and/or age brackets, and socioeconomic classes across countries, cities, subdivisions, and years. It also contains macroeconomic contextual data.
TelluBase covers 218 countries, 2600 cities, 2500 primary subdivisions, and 25000 secondary subdivisions for the years 2000–2050.
This unique database enables you to understand and quantify consumer economics at a granular level beyond what currently exists.