Rating sovereign credit risk: A simulation for advanced economics and finance students

Abstract

The authors of this article propose a classroom simulation designed for advanced economics or finance courses whereby student teams role-play Moody’s sovereign credit risk analysts. Despite the importance of sovereign credit risk ratings in affecting the funding liquidity of countries, the process generating ratings is a black box. The authors use active and experiential learning techniques to guide student teams in mimicking the process used by Moody’s analysts to assign a sovereign credit risk rating to one of 12 diverse countries. An accompanying YouTube video guides students in navigating three Web sites to retrieve macroeconomic data informing sovereign credit risk ratings. The simulation may be utilized in face-to-face and synchronous online environments.

Keywords:

• Classroom experiments
• credit rating agencies
• economics education
• money and banking
• sovereign debt
• undergraduate teaching

JEL CODES:

• A2
• A22
• F65
• G01
• G24
• H63
• N20

Acknowledgments

The authors thank an anonymous referee, an associate editor, and the editors for valuable suggestions and comments.

Notes

1 Classification of income levels and regions follows World Bank designations. High-income countries are Germany, the United Kingdom, and the United States; upper-middle-income countries are Brazil and China; lower-middle-income countries are Egypt, India, Mexico, Turkey, and Russia; and low-income countries are Ethiopia and Uganda.

2 Given the interactive nature of the simulation debrief—which also serves to solve the free-rider problem in group work—it will necessarily be lost in an asynchronous online course, making the simulation unsuited to this modality.

3 The YouTube video may be accessed here: https://www.youtube.com/playlist?list=PLAphkrW_YmxhXm2kz2uROcWIWNCqlkXiJ.

4 While instructors certainly have the flexibility to choose their own weighting scheme, Ruder, Maier, and Simkins (2021) note that to effectively motivate student accountability in group settings, the shared group grade must be a significant component of an individual student’s grade. For instance, they cite the example of team-based learning courses where team quizzes on assigned reading typically account for 15–20 percent of an individual student’s course grade. In our view, a 15 percent weight applied to the group grade effectively motivates accountability without ­making a student’s individual grade excessively vulnerable to the efforts of group members.

5 Moody’s evaluates GDP per capita to assess a country’s economic strength, the inflation rate to assess institutions and governance strength, general government debt (as a percentage of GDP) to assess fiscal strength, and the Gini coefficient as well as domestic political and geopolitical risk to assess susceptibility to event risk.

6 Moody’s scale appears as Exhibit 11 (Hornung and Marty [2019], 52) of its 2019 Sovereign Ratings Methodology.

7 Using the group scorecard as an answer key may be a reasonable approach to limiting grading time because it is the result of a vetting process overseen by the instructor during the debrief.

8 The instructor Excel grading tool may be accessed using the link below. The first sheet of the Excel document acts as a README file guiding instructors on how to use the grading tool. The second sheet of the Excel file is the grading tool. https://docs.google.com/spreadsheets/d/1IDZYCUSg75v9UHLvZ8iV0D4qvaC0j8Ez/edit?usp=sharing&ouid=105777218984453366505&rtpof=true&sd=true

9 Moody’s Sovereign Ratings Methodology can be retrieved in step 2 of the student assignment. Video directions are provided with the YouTube video referenced in note 3.

10 See note 8.

11 The sample student assignment completed for Haiti may be found here: https://drive.google.com/file/d/1Eyzu5uMbbMqiyht8ri9YkiRywuLL-1s4/view?usp=sharing