Comments on: Sovereign default datapoints of the day A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 By: Greycap Wed, 07 Jul 2010 15:38:41 +0000 OK, suppose God comes down from heaven and informs you that your recovery rate assumption is correct and that you have correctly modeled the joint stochastic evolution of hazard rates and FX. Now you can confidently imply a default probability, but what is the point of the exercise?

What you have is a risk-neutral probability, i.e. the probability that gives you the right price in your chosen units. If your goal is to make inferences about “real” probabilities, this is every bit as circular as it sounds, because it embeds the price of risk. One expects (hopes?) this price is positive, in which case the implied probability must be higher than the “real” one. But if DanHess is right, then the price of risk might be negative, giving you probabilities that are too low – maybe even negative themselves. A negative probability would be a clear indication that some of your assumptions are wrong, but in general you can’t decide whether your probability is too high or too low without knowing the “real” probability in the first place.

By: Rikh Wed, 07 Jul 2010 10:28:54 +0000 1. Iceland imho is already defaulting at the moment, according to international treaties they have to reimburse the UK and Holland (may be the status of part of that amount is somewhat dodgy, but now they are paying nothing at all).
2. Recovery rate standardization is imho totally wrong.
Spain with 50-55% debt giving a haircut which would leave only 20-22% just as an example. It would become the best kid in the block by far. Spain is one of the most important countries in this respect.
3. EU countries have the advantages of a safety-net and a remaining relatively strong own currency (providing they stay in the EU and EURO-zone), post haicut debt is in a ‘normal’ currency.
4. CDS is probably not such a good measure because of the reason mentioned by DanHess, they are relatively expensive. Basically you need collateral and not margin.
5. Volumes of eg Greek debt and CDS are marginal and it doesnot look like the market has found an equilibrium for the new situation yet, with some sellers and very few normal buyers.
6. Influence of ECB programm however would suggest an even higher chance of default for Greece.

By: DanHess Tue, 06 Jul 2010 23:07:56 +0000 Part of the widening may reflect an awareness that CDSs are unlikely to be bailed out by sovereigns anymore in the future, and that the great CDS bailout of 2008 is unlikely to be repeated now that the public knows about these instruments.

A strong case is to be made that until recently CDS coverage was *underpriced* because of an implicit government backstop.

By: FelixSalmon Tue, 06 Jul 2010 21:02:01 +0000 Sorry John, well spotted. Fixed.

By: JohnOmeara Tue, 06 Jul 2010 19:44:10 +0000 In the fifth paragraph it read “I see no good reason at all for assuming that recovery values in Croatia will be higher than in Greece”. I believe that the CMA assumption is the other way and that you are saying you see no reason to assume the recovery value of Greek debt will be higher than that of Croatia.

By: q_is_too_short Tue, 06 Jul 2010 18:48:55 +0000 most sovereign cds (not european though) also trade in a different currency than the country they are insuring, so there is an FX rate assumption built in there as well. this can be quite significant — you are asking what the relative FX rate move would be given a sovereign default. good luck untangling this.