Risky Sovereign Capital Structure: Macrofinancial Diagnostics

Posted: 30 Apr 2015 Last revised: 16 Apr 2018

Date Written: April 15, 2015


We build an enhanced structural credit risk Merton style model for a risky sovereign having both domestic and foreign debt outstanding. If earlier research was mainly focused on the fundamental values of the respective local and foreign currency bonds, here we move forward by elaborating on pricing them consistently in an out of equilibrium market situation. Such is rather a norm than an exception since a country rarely achieves to operate at the macro potential. We propose a consistent working setting which provides also a powerful tool to analyze in a uniform way from a no-arbitrage macrofinancial point of view policies and flows affecting the capital structure of the sovereign. We put a special emphasis on issues related to FDI, FX interventions and sterilizations, debt issuance and buybacks, and monetary policy open market operations and their influence on the bond prices and risky sovereign spreads. They matter in relative value analysis and combined with considerations whether the economy functions at the potential under an optimal capital structure provide relevant strategic and tactical investment views as well as policy prescriptions for optimal macro management. We conclude with an empirical application to a comprehensive set of emerging market countries.

Keywords: capital structure, Merton model, risky sovereign spreads, macrofinancial flows, macro potential

JEL Classification: F30, E43, G12, G15, C58

Suggested Citation

Yordanov, Vilimir, Risky Sovereign Capital Structure: Macrofinancial Diagnostics (April 15, 2015). Available at SSRN: https://ssrn.com/abstract=2600238

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