The ratcheting up of military tensions on the Korean peninsula has lifted South Korea’smarket-based measures of sovereign credit risk. South Korea’s five-year sovereign EDF1,which measures the probability that the government will default on a bond during the nextfive years, rose to 0.28% on Monday August 14, before easing throughout the week. This wasthe highest reading on South Korea’s sovereign EDF since 2013. The spread on the five-yearCDS contract, which is the primary driver of the five-year sovereign EDF, peaked at 71bp onMonday. By week’s end, the sovereign EDF had fallen to 0.25%.。    Tensions between North and South Korea have increased in recent weeks, amplified bydisplays of brinkmanship from the governments of North Korea and the US. In the eventof a military conflict, South Korea would be caught in the crossfire and would suffer severeeconomic and human costs. In one scenario, for example, if the North Korean government collapsed, the South Korean governmentwould be forced to take control of the entire Korean peninsula, imposing enormous costs on its government. Government debt inSouth Korea remains relatively low at 39% of GDP, which has helped to prevent a more dramatic increase in its sovereign creditrisk. If we convert the five-year sovereign EDF to a market-implied rating, it now sits at Baa1. This suggests that it is still comfortablyinvestment grade, although this metric is five notches below its Moody’s Investors Service agency rating of Aa2.

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