Assessing country risk using multicriteria classification approaches

Banks, international lending institutions, investors and financial managers have focused their attention on developing effective country risk models during the last two decades. Country risk evaluation is an important component of investment and capital budgeting decisions of all investors but especially international investors. The increased internationalization of investment in recent decades has exposed investors to a growing number of risks associated with events in many different countries. Consequently, substantial resources are now devoted to country risk analysis by international investors who realize the iportance of identifying, evaluating and managing the risks they face. For many international investors, profits and opportunities for growth have increasingly come to depend on how effectively they cope with international uncertainties. This study presents the contribution of multicriteria decision aid in country risk assessment. The proposed approach is based on multicriteria decision aid and classification methods, namely the UTADIS method (UTilites Additives DIScrimination) and the MHDIS method (Multi-group Hierarchical DIScrimination). Both methods lead to the development of country risk classification models in the form of additive utility functions that classify a set of countries into predefined risk classes. The efficiency of the proposed methods is illustrated through a case study using data made available by the World Bank. The two multicriteria methods are employed to develop appropriate models for the classification of countries into four risk groups, according to their creditworthiness and risk level. Several validation tests are performed in order to compare the classification results of the two methods with the corresponding results obtained from Linear Discriminant Analysis.