An Assessment of Kenya’s Sovereign Risk

Abstract

This paper sought to assess Kenya’s sovereign risk by applying the bottom-up, micro assessment approach as espoused by Edward Altman and Herbert Rijken, which proposes that the risk profile of a sovereign mirrors the risk profile and health of its private sector. The study sought to determine whether the Z-score risk model developed by Edward Altman can be applied to measure Kenya’s sovereign risk. Using the Z-score model, Kenya’s yearly historical probability of default over a period of 7 years was calculated and results validated by back-testing and application of statistical tests. Finally, the study considered whether the Z-score model could be adapted for Kenya’s operating environment. The findings of the study inferred that Kenya’s historical probability of default and by extension its sovereign risk, as measured using the z-score model, has historically been low. This conclusion, low probability of default, was found to be consistent with the conclusions drawn using the more conventional macro based sovereign risk measurement models (S&P and the EIU models). However, the validation processes indicated that the micro based z-score model was not sufficiently robust to be applied to measure Kenya’s sovereign risk and the Z-score model would need to be modified and adapted to better reflect Kenya’s dynamics. The study has implications for monetary and fiscal policy, private sector policy as well as sovereign risk model development for developing economies such a Kenya.