Sovereign risk

Although government bonds in the government's own currency are usually regarded as risk free (because governments need never run out of money they issue themselves), there are certain risks involved in dealing with governments.

As a country is a sovereign entity, it is impossible or difficult for someone dealing with a government to enforce repayments of debt (a government can even change the law to avoid repayments, if it wishes to), hence the term sovereign risk. Many governments have defaulted and there is little investors can do about it (whereas with a non-governmental body investors would sue). The risk that this will happen is sovereign risk.

Sovereign risk can also apply to other dealings with governments, such as undertaking government contracts. Its most wide definition is that of all risks arising from the ability to governments (as sovereign bodies) to pass laws and regulations.

The assessment of sovereign risk on government debt is in some ways similar to the assessment of the default risk of corporate debt. It is complicated by the relevance of political issues which may lead a government to default even if it could pay.

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