RT Journal Article
SR Electronic
T1 Two-Factor Structural Model of Determinants of Brazilian Sovereign Risk
JF The Journal of Fixed Income
FD Institutional Investor Journals
SP 48
OP 59
DO 10.3905/jfi.2004.419574
VO 14
IS 1
A1 Ajax Moreira
A1 Katia Rocha
YR 2004
UL https://pm-research.com/content/14/1/48.abstract
AB A two-factor credit risk structural model is based on the contingent claims approach for pricing Brazilian sovereign risk implicit in the Brazilian government bond. Default probability is captured by two variables: the observed macroeconomic fundamental that triggers default, and the unobserved agents' expectation, identified as the risk premium evolving smoothly over time. Applications of the model include establishing the effect of the country's indebtedness level for different credit spreads; estimating the default probability and the associated risk premium; and forecasting the credit spread. The model shows forecasting ability. Both fundamentals and expectations are significant in explaining the credit spread evolution, and the time-varying risk premium suggests latitude to reduce the credit spread as a consequence of an improvement in expectations rather than fundamentals.