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Do Macro-economic Fundamentals Price Sovereign CDS Spreads of Emerging Economies?

  • Plank, Thomas J.

    (University of Pennsylvania)

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    This paper studies the extent to which macro-economic variables govern the dynamics of emerging markets sovereign CDS spreads. I propose a structural model of sovereign credit risk based on observed exports, imports and international reserves. Using these macro fundamentals, I define a country's ability to pay as the maximum amount of foreign currency available for repayment of non-domestic debt. The joint dynamics of the ability to pay and a sovereign's outstanding external debt determine the level of country default risk and thus the CDS spreads. I implement the model for a sample of 6 emerging economies for a period covering the recent financial crisis. A calibrated version of the model captures the widening of sovereign spreads during the crisis and provides a good _t for the time-series dynamics of CDS spreads. Lastly, I use the model to measure the market-implied level of country liabilities. On average, the value of implied external debt is 13% larger than the reported level of debt.

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    File URL: http://finance.wharton.upenn.edu/weiss/wpapers/2010/10-5.pdf
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    Paper provided by University of Pennsylvania, Wharton School, Weiss Center in its series Working Papers with number 10-5.

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    Date of creation: Jun 2010
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    Handle: RePEc:ecl:upafin:10-5
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