Approaches to the Quantification of Country Risk

Paul Domjan

The quantification of country risk is becoming increasingly important. From an organisational perspective, a best practice process for managing country risk should support an organisation’s ability to do three things well:

• • make relative capital allocation and risk budgeting decisions;
• • decide when to enter and exit new countries, whether through direct operation or exposure to counterparties; and
• • identify, prepare for, and respond effectively to, challenges in the countries in which it operates.

However, achieving these goals creates a tension between the need for qualitative and quantitative approaches to risk management. On the one hand, many aspects of country risk (eg, political risk) appear fundamentally qualitative. On the other hand, many of the decisions that organisations make based on country risk assessments require, or at least lend themselves to, quantification. For example, relative capital allocation decisions require comparing risk between countries and assessing risk–return trade-offs, both of which imply the need to quantify an aggregate country risk level rather than focus on expert assessment of different areas of