I have been thinking about sovereign bonds a lot recently. Ten year Irish government bonds were yielding 9.2% on the last day of 2010 when UK yields were 3.2% and Italian were 4.9%. As at 8 November 2011 the latest yields were 8.3% for Ireland, 2.2% for the UK and 6.7% for Italy.
So we agree that the market believes not all government bonds are risk free. As actuaries we have to try to quantify how much of this spread is credit (default) risk. The Society of Actuaries in Ireland produced a useful paper in May 2011 that summarised a range of approaches to try to quantify this credit component. The full paper (and presentation and podcast!) is here:
The interesting table is included in the Appendix to the paper:
|Approach to estimating credit risk||% of the excess spread that can be considered credit risk|
|Credit default swaps||>100%|
|Market based metrics||75% – 90%*|
|Solvency II illiquidity premium||92%|
|Historical experience approach||**|
|Bank of England’s analysis on corporate bonds||>50%|
* Based on data at 15 February 2011
** Depends on the analysis of historical experience.
I’m looking forward to discussion of this at the life convention in Liverpool. I expect (and hope) the International Actuarial Association attendees will bring an interesting international viewpoint to the debate.