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Sovereign risk in a structural approach: Evaluating sovereign ability-to-pay and probability of default

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  • Karmann, Alexander
  • Maltritz, Dominik
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    Abstract

    We quantify the probability that a sovereign defaults on repayment obligations in foreign currency. Adopting the structural approach as first introduced by Merton, we consider the sovereigns ability-to-pay, characterised by the sum of discounted future payment surpluses, as the underlying process. Its implicit volatility is inferred from market spreads. We demonstrate for the case of Latin America and Russia that our approach indicates default events well in advance of agencies and markets. --

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    Bibliographic Info

    Paper provided by Dresden University of Technology, Faculty of Business and Economics, Department of Economics in its series Dresden Discussion Paper Series in Economics with number 07/03.

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    Date of creation: 2003
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    Handle: RePEc:zbw:tuddps:0703

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    Web page: http://www.tu-dresden.de/wiwi/
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    Keywords: Sovereign Risk; Probability of Default;

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    1. Geske, Robert, 1977. "The Valuation of Corporate Liabilities as Compound Options," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 12(04), pages 541-552, November.
    2. Richard Cantor & Frank Packer, 1996. "Determinants and impact of sovereign credit ratings," Economic Policy Review, Federal Reserve Bank of New York, issue Oct, pages 37-53.
    3. Kenneth Rogoff, 1999. "International Institutions for Reducing Global Financial Instability," NBER Working Papers 7265, National Bureau of Economic Research, Inc.
    4. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-70, May.
    5. Stanley Fischer, 1999. "On the Need for an International Lender of Last Resort," Journal of Economic Perspectives, American Economic Association, vol. 13(4), pages 85-104, Fall.
    6. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
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    Cited by:
    1. Sottile, Pedro, 2013. "On the political determinants of sovereign risk: Evidence from a Markov-switching vector autoregressive model for Argentina," Emerging Markets Review, Elsevier, vol. 15(C), pages 160-185.

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