Financial risk assessment of local governments: a European comparison.

Summary The research proposes to identify the determinants of the assessment of the risk of default of European local governments in four countries: Spain, France, Italy, and Sweden. The first part presents a comparison of local systems in these countries in order to assess the risk arising from the regulatory environment. Then, after studying local accounting information in Europe, a common risk analysis vector composed of 19 accounting and socio-economic variables is constructed on the basis of published information. The second part addresses the discretionary risk generated by local financing choices from the perspective of financial theory. We study the sharing of risk between the local government group and the lenders when financing an investment project through a bond issue. The implementation of an option analysis model of local default leads us to formulate proposals on the main determinants of the investors' risk assessment. The third part tests these propositions on a sample of 55 European local governments over the period 1995-1998. A first study focuses on the determinants of rating. A second study identifies the factors that influence the risk premium of 36 Franco-Spanish bonds in 1998. A third study, based on interviews, focuses on the enhanced bonds issued by the city of Marseille. The local socio-economic environment seems to have an important weight in the risk assessment, along with the level of indebtedness and the structure of current revenues. Finally, it appears that investors rely as much on the accounts as on the rating to assess the default risk premium.