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.

]]>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. ]]>

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

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