To quantify the gap between market-perceived and observed credit risk in emerging markets, this study compares two indicators:
Default spread (A) represents the credit risk priced in by the market.
The analysis uses Damodaran (2025[1])’s adjusted default spread, derived from sovereign credit ratings and Credit Default Swap (CDS) spreads, with the latest update from January 9, 2025.
It is important to note that this indicator is based on sovereign data and is used here as a proxy for investor-perceived country risk, which may not fully reflect private sector credit conditions.
Expected loss (B) reflects actual credit performance.
The research used country-level data (Average Annual Default Rate and Average Annual Recovery Rate) from Global Emerging Markets (GEMs) database (2024[2]) from 1994 to 2023, for private counterparts.
Expect loss rate is calculated as:
Annual Default Rate x (1 – Average Annual Recovery Rate)
The credit risk perception gap is then computed for each country as the difference between market-implied risk and historical loss:
Credit risk perception gap = A – B
A positive gap suggests that markets demand higher compensation than historical records justify, potentially due to factors such as investor risk aversion, liquidity constraints, or forward-looking uncertainty.