Risk of Default in Latin American Brady Bonds
The 1989 Brady Plan, named after the former US Treasury Secretary Nicholas Brady, was the restructuring and reduction of several emerging countries' external debt into bonds with US Treasury bonds as collateral. So far no country has ever defaulted payments, yet the market value of these bonds is usually significantly lower than equivalent 'risk-free' bonds. Mexico was the first country to issue Brady bonds, in February 1990, and there soon followed other Latin American, Eastern European and Asian countries. In this paper, we describe a stochastic model for the instantaneous risk of default, applicable to many fixed-income instruments and Brady bonds in particular. We make some simplifying assumptions about this model and a model for the riskless short-term interest rate. These assumptions allow us to find explicit solutions for the prices of risky zero-coupon bonds and floating rate coupons. We apply the model to Latin American Brady bonds, deducing the risk of default implied by market prices.
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