Defaultable sovereign debts with macroeconomic conditions and periodic news

Weiping Li
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Weiping Li: Civil Aviation Flight University of China (CAFUC), Guanghan, Sichuan Province 618307, P. R. China2Watson Faculty of Finance, Oklahoma State University, Stillwater, Oklahoma 74078-0613, USA

International Journal of Financial Engineering (IJFE), 2021, vol. 08, issue 01, 1-35

Abstract: This paper presents a default structural model of sovereign debt under macroeconomic conditions and periodic news. I model the macroeconomic conditions to be a finite state of Markov chain, and the periodic news to be a predictable factor in the drifting and the diffusion parts in the underlying value of the representative firm. The innovation of our model is to characterize the price of sovereign debt and the sovereign credit spread associated with macroeconomic conditions, and to model periodic news with both continuous factors and periodic factors. Both the defaultable yield-to-maturity, the sovereign credit spread and the duration are related to the finite state of Markov chain and periodic news. Furthermore, we obtain a closed-form solution for the two-state Markov chain associated to macroeconomic conditions and periodical information update.

Keywords: Macroeconomic conditions; periodic news; Markov chain; defaultable sovereign debt; sovereign credit risk (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1142/S2424786321500122

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