A Structural Balance Sheet Model of Sovereign Credit Risk

35 Pages Posted: 22 Dec 2011

See all articles by Pascal Francois

Pascal Francois

HEC Montreal - Department of Finance

Georges Hübner

HEC Liège

Jean-Roch Sibille

Riskdynamcis

Date Written: December 21, 2011

Abstract

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

Francois, Pascal and Hübner, Georges and Sibille, Jean-Roch, A Structural Balance Sheet Model of Sovereign Credit Risk (December 21, 2011). Available at SSRN: https://ssrn.com/abstract=1975353 or http://dx.doi.org/10.2139/ssrn.1975353

Pascal Francois (Contact Author)

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada
514-340-7743 (Phone)
514-340-5632 (Fax)

Georges Hübner

HEC Liège ( email )

Rue Louvrex 14, Bldg. N1
Liege, 4000
Belgium
+32 42327428 (Phone)

Jean-Roch Sibille

Riskdynamcis ( email )

47-48 Boulevard du Régent
Brussels, B-1000
Belgium

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