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Capco announces new early warning system for European debt default

The Capco CEPIX Index provides country-by-country analysis and profiling of Eurozone members’ propensity for sovereign debt default

Capco, a global business and technology consultancy dedicated solely to the financial services industry, announced today that it has developed an advanced sovereign debt default risk metric: the CEPIX Index.

Peter Schurau, Capco European CEO, says: “Potential sovereign debt default remains a front of mind issue in the Eurozone, as recent events have underlined yet again. The Capco CEPIX Index will provide practitioners, analysts and commentators with insightful information around the challenging questions that underlie sovereign debt, as well as stimulating discussion about the current crisis.”

CEPIX profiles the likelihood in percentage terms of sovereign debt default over a 12-month time period for a Eurozone country, working within an upper limit of 95%, from a base of 0%.

Damiano Brigo, Professor and co-Head of Mathematical Finance, Imperial College London, designed CEPIX to combine two input streams. The first is a set of government benchmark bond indices, reflecting market view on credit risk of the underlying debt. The second input uses rating agencies’ published default probabilities. The output is a cross-referred country analysis of each Eurozone member’s likelihood of sovereign debt default. The higher a country’s debt-to-GDP ratio is, relative to other countries’ ratios, the more the market view is weighted. Besides cross-country analysis, historical data is averaged and presented in an interactive graph that enables the end-user to compare the likelihood of default over time.

Professor Brigo, who is also Director of the Capco Research Institute and Editor of Capco’s Journal of Financial Transformation, explains: “At the technical level, CEPIX bridges market implied probabilities of individual country sovereign debt default and those published by rating agencies. We modelled the indicator to avoid the occasional sharp changes created by discrete rating agency updates, while smoothing sometimes unnecessarily high volatility of market implied default risks stemming from risk premia.”

Putting the new metric in context, Schurau comments: “CEPIX is designed to raise awareness of risk as a result of the current balance of payments crisis and to help financial institutions and governments prepare for sovereign debt deterioration or default. Overall, the index should be interpreted as an indicative quantity and auxiliary tool rather than a fundamental predictor. But we do believe CEPIX will deliver insights that help governments and institutions to better manage risk. In short, we consider that CEPIX will become an acknowledged source for industry research.”

Brigo’s hope for the new indicator, going forward, is that: “CEPIX will start a discussion that leads to deeper insights into the European crisis and helps define a reliable threshold for determining the extreme yet still possible scenario of ‘Euro Breakup’.”