Sovereign risk in a structural approach: Evaluating sovereign ability-to-pay and probability of default

Alexander Karmann and Dominik Maltritz

No 07/03, Dresden Discussion Paper Series in Economics from Technische Universität Dresden, Faculty of Business and Economics, Department of Economics

Abstract: We quantify the probability that a sovereign defaults on repayment obligations in foreign currency. Adopting the structural approach as first introduced by Merton, we consider the sovereigns ability-to-pay, characterised by the sum of discounted future payment surpluses, as the underlying process. Its implicit volatility is inferred from market spreads. We demonstrate for the case of Latin America and Russia that our approach indicates default events well in advance of agencies and markets.

Keywords: Sovereign Risk; Probability of Default (search for similar items in EconPapers)
JEL-codes: F34 (search for similar items in EconPapers)
Date: 2003
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Citations: View citations in EconPapers (3)

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