Default Probabilities and Expected Recovery: An Analysis of Emerging Market Sovereign Bonds

29 Pages Posted: 19 Oct 2005

See all articles by Liz Dixon-Smith

Liz Dixon-Smith

Reserve Bank of Australia

Roman Goossens

Bank of England

Simon Hayes

Bank of England

Date Written: May 2005

Abstract

We develop a simple bond pricing model to map the prices of individual EME sovereign bonds into term structures of implied (risk-neutral) default probabilities and expected recovery rates. Simple indices of bond spreads are found to be closely correlated with long-term risk neutral default probabilities, so may provide a straightforward way of monitoring shifts in investors' perceptions. But short-term risk neutral default probabilities behave quite differently, implying that there are periods of market-wide changes in volatility that do not show in measures of average spreads. Estimation of time-varying recovery rates appears to work best for countries in crisis, and suggests that expected recovery falls as the prospect of default becomes imminent. Movements in the median time to default generally appear plausible, both across time and across countries.

Suggested Citation

Dixon-Smith, Liz and Goossens, Roman and Hayes, Simon, Default Probabilities and Expected Recovery: An Analysis of Emerging Market Sovereign Bonds (May 2005). Bank of England Working Paper Series No. 261, Available at SSRN: https://ssrn.com/abstract=824125 or http://dx.doi.org/10.2139/ssrn.824125

Liz Dixon-Smith

Reserve Bank of Australia ( email )

GPO Box 3947
Sydney, 2000
Australia

Roman Goossens (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Simon Hayes

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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