Keywords: Credit, default, swap, sovereign, debt
Abstract: 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.
Full paper (461 KB PDF)
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Last update: July 22, 2003