Forecasting Sovereign Default risk with Merton’s Model

26 Pages Posted: 14 May 2011 Last revised: 25 Jan 2016

See all articles by Johan G. Duyvesteyn

Johan G. Duyvesteyn

Robeco Asset Management

Martin Martens

Erasmus University Rotterdam (EUR); Robeco Asset Management

Date Written: June 8, 2015

Abstract

Merton's structural model for sovereigns is proven to be useful to analyze the default risk of a country. We are the first to investigate how fast CDS spreads react to changes in model inputs and outputs. CDS spread changes strongly correlate with exchange rate returns, which are an input to the model. But CDS spread changes on average react with a delay to changes in model outputs such as the distance to default, the default probability and model spreads. Hence contingency claim analysis for sovereigns provides useful predictions for CDS spreads.

Keywords: Sovereign credit risk, structural model, emerging debt

JEL Classification: G13, G14

Suggested Citation

Duyvesteyn, Johan G. and Martens, Martin P.E., Forecasting Sovereign Default risk with Merton’s Model (June 8, 2015). Journal of Fixed Income, Vol. 25, No. 2, 2015. Available at SSRN: https://ssrn.com/abstract=1839470 or http://dx.doi.org/10.2139/ssrn.1839470

Johan G. Duyvesteyn

Robeco Asset Management ( email )

Rotterdam, 3011 AG
Netherlands

Martin P.E. Martens (Contact Author)

Erasmus University Rotterdam (EUR) ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands
+31 10 408 1253 (Phone)
+31 10 408 9162 (Fax)

Robeco Asset Management ( email )

Rotterdam, 3011 AG
Netherlands

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