A Structural Balance Sheet Model of Sovereign Credit Risk
35 Pages Posted: 22 Dec 2011
Date Written: December 21, 2011
This article studies sovereign credit spreads using a contingent claims model and a balance sheet representation of the sovereign economy. Analytical formulae for domestic and external debt values as well as for the financial guarantee are derived in a framework where recovery rate is endogenously determined as the solution of a strategic bargaining game. The approach allows to relate sovereign credit spreads to observable macroeconomic factors, and in particular accounts for contagion effects through the corporate and banking sectors. Pricing performance as well as predictions about credit spread determinants are successfully tested on the Brazilian economy.
Keywords: Sovereign Credit Spread, Balance Sheet, Recovery Rate, Contingent Claims Analysis, Contagion Effects
JEL Classification: G13
Suggested Citation: Suggested Citation