The Dynamics of the Option-Adjusted Spread of Brady Bond Securities

Franklin de O. Gonçalves () and Luiz Otavio Calôba ()
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Franklin de O. Gonçalves: Banco BBM
Luiz Otavio Calôba: FGV

Brazilian Review of Finance, 2003, vol. 1, issue 1, 89-112

Abstract: Brady bond securities represent a substantial fraction of emerging markets countries internationally tradable sovereign debt. The credit risk spread above and beyond the U.S. treasury curve for these securities is usually large in size and volatility. Moreover, most Brady bonds carry embedded options that lead to the existence of an Option-Adjusted Spread, OAS, which increase their risk profiles. In this paper we present an empirical study of the dynamics of Brady bonds OAS using a heath, Jarrow and Morton term structure pricing model. The dynamics of the spread shows that the proper risk management and pricing of these securities require the consideration of volatility in addition to the magnitude of the sovereign risk spread. That is, the proper risk measure for these securities would be the pair (OAS, OAS Volatility). A study of implied default probabilities is also presented. Our analysis is illustrated with bonds from Brazil, Argentina, Mexico, Poland, Bulgaria and the Philippines.

Keywords: pricing interest rate derivatives; credit risk; risk management; term structure models; Brady bonds (search for similar items in EconPapers)
JEL-codes: C63 F34 G13 (search for similar items in EconPapers)
Date: 2003
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Persistent link: https://EconPapers.repec.org/RePEc:brf:journl:v:1:y:2003:i:1:p:89-112

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