Country Risk: An Empirical Approach to Estimate the Probability of Default in Emergent Markets

Abstract

In this paper we have suggested a new methodology to estimate the probability of default of a country as a function of other macroeconomics variables. Such methodology is based in the valuation of the prices in the secondary market of bonds issued by debtor countries. We have chosen the Brady bonds because their institutional characteristics do not depend on the issuer country which allows us to build a homogeneous panel. The methodology proposed takes elements of traditional models such as the functional structure of the probability and elements of term structure models. The paper demonstrates a new way to extract sovereign risk, implicit in trade bond prices.