The Bulgarian Foreign and Domestic Debt – A No-Arbitrage Macrofinancial View

45 Pages Posted: 5 Jun 2012 Last revised: 19 Dec 2015

Vilimir Yordanov


Date Written: March 5, 2012


Bulgaria started the transition in the early 90’s with a sovereign default and debt restructuring. Later on, under a strict fiscal discipline, the country succeeded to reduce significantly its debt burden and is currently among the top EU performers in that respect. The current debt outstanding is composed mainly of local currency treasuries issued on the domestic market as well as Eurobonds and Global bonds on the international one. These instruments give rise to two risky spreads - credit and currency. The Currency Board Arrangement and the fixed exchange rate regime the country follows prevent from a discretionary monetary policy and this gives relative stability to the bonds’ yields and the risky spreads. Their financial role starts dominating over any macroeconomic one making them a natural object for investigation with financial engineering tools. The main focus of the paper is an analysis of the informational content of the risky spreads in a multifaceted way from noarbitrage, financial, and macroeconomic points of view. For the purpose we build from scratch both a reduced form model in a Heath-Jarrow-Morton setting and a structural one which extends the classical Merton model to the case of a risky sovereign. We estimate the former model and extract the priced factors. Then we relate them to a set of indicators the latter model provides as well as to suitable macrofinancial and macroeconomic variables. The setting allows to have a better understanding of the spreads’ risk drivers, which could be useful not only to the participants in the bond market, but also for drawing qualitative conclusions what kind of optimal debt issuance policy the country could follow.

Keywords: arbitrage, term structure, credit risk, credit spread, currency spread, HJM

JEL Classification: F31, G12, E43, C58

Suggested Citation

Yordanov, Vilimir, The Bulgarian Foreign and Domestic Debt – A No-Arbitrage Macrofinancial View (March 5, 2012). William Davidson Institute Working Paper No. 1032. Available at SSRN: or

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