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What did the credit market expect of Argentina default? Evidence from default swap data

  • Frank X. Zhang
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    This article explores the expectations of the credit market by developing a parsimonious default swap model, which is versatile enough to disentangle default probability from the expected recovery rate, accommodate counterparty default risk, and allow flexible correlation between state variables. We implements the model to a unique sample of default swaps on Argentine sovereign debt, and found that the risk-neutral default probability was always higher than its physical counterpart, and the wedge between the two was affected by changes in the business cycle, the U.S. and Argentine credit conditions, and the overall strength of the Argentine economy. We also found that major rating agencies had assigned over-generous ratings to the Argentine debt, and they lagged the market in downgrading the debt.

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    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2003-25.

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    Date of creation: 2003
    Date of revision:
    Handle: RePEc:fip:fedgfe:2003-25
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    1. Patrick Houweling & Ton Vorst, 2002. "An Empirical Comparison of Default Swap Pricing Models," Tinbergen Institute Discussion Papers 02-004/2, Tinbergen Institute.
    2. Gurdip Bakshi & Dilip Madan & Frank Zhang, 2001. "Investigating the sources of default risk: lessons from empirically evaluating credit risk models," Finance and Economics Discussion Series 2001-15, Board of Governors of the Federal Reserve System (U.S.).
    3. Sarig, Oded & Warga, Arthur, 1989. " Some Empirical Estimates of the Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 44(5), pages 1351-60, December.
    4. Darrell Duffie & Jun Pan & Kenneth Singleton, 2000. "Transform Analysis and Asset Pricing for Affine Jump-Diffusions," Econometrica, Econometric Society, vol. 68(6), pages 1343-1376, November.
    5. Gurdip Bakshi & Dilip Madan & Frank Zhang, 2001. "Understanding the role of recovery in default risk models: empirical comparisons and implied recovery rates," Finance and Economics Discussion Series 2001-37, Board of Governors of the Federal Reserve System (U.S.).
    6. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March.
    7. SOLNIK, Bruno & COLLIN-DUFRESNE, Pierre, 2000. "On the term structure of default premia in the Swap and Libor markets," Les Cahiers de Recherche 704, HEC Paris.
    8. White, Halbert, 1982. "Maximum Likelihood Estimation of Misspecified Models," Econometrica, Econometric Society, vol. 50(1), pages 1-25, January.
    9. Pearson, N.D. & Sun, T.S., 1991. "An Empirical Examination of the Cox, Ingersoll and Ross Model of the Term Structure of Interest Rates," Papers fb-24, Columbia - Graduate School of Business.
    10. Hull, John & Predescu, Mirela & White, Alan, 2004. "The relationship between credit default swap spreads, bond yields, and credit rating announcements," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2789-2811, November.
    11. Jarrow, Robert A & Turnbull, Stuart M, 1995. " Pricing Derivatives on Financial Securities Subject to Credit Risk," Journal of Finance, American Finance Association, vol. 50(1), pages 53-85, March.
    12. Gregory R. Duffee, 1996. "Estimating the price of default risk," Finance and Economics Discussion Series 96-29, Board of Governors of the Federal Reserve System (U.S.).
    13. Gregory R. Duffee, 2002. "Term Premia and Interest Rate Forecasts in Affine Models," Journal of Finance, American Finance Association, vol. 57(1), pages 405-443, 02.
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