Default Recovery Rates and Implied Default Probability Estimations: Evidence from the Argentinean Crisis

Sosa Navarro, Ramiro (2005): Default Recovery Rates and Implied Default Probability Estimations: Evidence from the Argentinean Crisis.

Abstract

This paper applies the model presented by J. Merrick Jr. (2001) to estimate both the default recovery rates and the implied default probabilities of the Argentinean Sovereign Bonds during the crisis which took place in December 2001. Between October 19th and December 24th 2001, the average bond price level re�ected a downward trend, falling from USD 56.8 to USD 26.5 for each USD 100 face value. Similarly, default recovery rates descended from USD 38.7 to USD 20.8 whereas the base default probability registered an increase from 19.4% to 45.5%. Thus, bond price volatility could be explained in terms of these two embedded determinants. According to the model, bond prices were overvalued by USD 3.92 on average, which amounts to 12.9%; even when it is generally assumed that the default was foreseen by the market in December 2001. In accordance with private estimations of the Argentinean debt haircut which set it at 70% and the recovery rate estimated by the model which amounts to USD 21.7, Argentina would have overcome its default with a country risk premium of around 1960 basic points. Such a high country risk spread after debt restructuring would fully justify a deep haircut over the face value, the temporal term structure and interest rate coupons.

• Item Type: MPRA Paper
• Language: English
• Keywords: Sovereign Default, Recovery Estimates
• Subjects: G - Financial Economics > G1 - General Financial Markets; G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets

References

Altman Edward, Andrea Resti and Andrea Sironi (2004), Default Recovery Rate in Credit Risk Modeling: A Review of the Literature and Empirical Evidence. Economic Notes by Banca dei Monte dei Paschi di Siena. Volume 33.

Andritzky Jochen (2004). Implied Default Probabilities and Default Recovery Ratios: And Analysis of Argentine Eurobonds 2000 -2002. University of Saint Gallen, Swiss Institute of Banking and Finance.

Bhanot, K., (1998). Recovery and Implied Default Brady bonds. The Journal of Fix Income 8(1), 47 �51.

Edwards Sebastian and Susmel Raúl, (1999). Contagion and Volatility in the 1990s. CEMA Working Papers 153.

Fons, J., (1987). The default premium and corporate bond experience. The Journal of Finance 42(1), 81-97.

Hurley, W. J. and Jonson, L.D., (1996). On the pricing of bond default risk. The Journal of Portfolio Management 22(2), 66 �70.

Jonkart, M., 1979. On the term structure of interest rate and the risk of default: an analytical approach. Journal of banking and Finance 3(3), 253 �262.

Merrick John J. Jr. July (2000). Crisis Dynamics of Implied Default Recovery Ratios: Evidence from Russia and Argentina. The Journal of Banking and Finance 25, (1921-1939).

Fridson Martin, Garman C.M., Okashima K. (2000). High Yield. Recovery Trends: Any Usefulness Whatsoever?. Merrill Lynch

Sturzenegger, Federico (2000), �Defaults Episodes in 90s: Factbook, Tool-kit and Preliminary Lessons�, prepared for the World Bank

Sturzenegger, Federico (2004) �Tools for the Analysis of Debt Problems�. Journal of Restructuring Finance.