Crisis Dynamics of Implied Default Recovery Ratios: Evidence from Russia and Argentina

by John J. Merrick, Jr. of New York University

October 2001

Abstract: This paper extracts both the implied default recovery ratio and the risk-neutral default probability term structure for Russian Federation and Republic of Argentina US dollar Eurobonds during the 1998 Russian default crisis. This crisis provides a unique window into the impact of changing default probabilities and recovery ratio assumptions on credit-sensitive sovereign bond prices. For the Russian Eurobonds, the sample paths suggest a two-phase crisis revaluation. Shifts in default probabilities account for most of the initial price collapse. Marked decreases in the implied default recovery ratio dominate the second phase. Investors never cut their recovery value assumptions for Argentine debt.

JEL Classification: G12, G15.

Keywords: credit crisis, default risk, recovery value, investments.

Published in: Journal of Banking & Finance, Vol. 25, No. 10, (October 2001), pp. 1921-1939.

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