Crisis dynamics of implied default recovery ratios: Evidence from Russia and Argentina

Abstract

The Russian GKO default crisis provides a unique window into the impact of changing default probabilities and recovery ratio assumptions on credit-sensitive sovereign bond prices. This paper introduces a joint implied parameter approach to extract both the expected recovery ratio and the default probability term structure. The methodology is applied to both Russian Federation and Republic of Argentina US dollar-denominated Eurobonds before and after the GKO crisis. For the Russian bonds, the sample paths suggest a two-phase revaluation. Shifts in default probabilities account for most of the initial price collapse. Marked decreases in the projected default recovery ratio dominate the continued Russian bond price declines. The "contagion effect" impact of the default crisis on the Argentine Eurobond market actually resembles the Russian case much more than the raw price data indicate. The crucial Argentine distinction is that investors never cut recovery value assumptions.

Predicting default probabilities and implementing trading strategies for emerging markets bond portfolios

“…Market prices of Brady discount bonds have been used in the empirical investigation of Claessens and Pennacchi (1996), Izvorski (1998) and Pages (2001), whereas Eurobonds have been used by Merrick (2001) and Duffie, Pedersen and Singleton (2003).…”

Extracting Default Probabilities from Sovereign Bonds

“…From the empirical viewpoint, all these crises motivated research where the main focus was to extract implied probabilities of default and recovery rates from market data, to give more support to trading desks on the design and evaluation of credit derivatives products. For instance, Merrick (2001) introduces a joint implied parameter approach to extract the expected recovery rates and default probabilities term structure from Russian bonds. Andritzky (2002) In our empirical application, we study the behavior of investor's risk perception within an important fixed income emerging market: The Brazilian Global Bonds market.…”

Overpricing in Emerging Market Credit-Default-Swap Contracts: Some Evidence From Recent Distress Cases

“…Since bond prices depend on the expected recovery value, it is possible to derive recovery values implied by market prices, especially during a crisis. Merrick (2001) shows the effect of Russia's restructuring terms on domestic bonds in 1998 on the implied recovery rates on Eurobonds in Russia and Argentina.…”