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Modelling Sovereign Debt Rescheduling Probabilities in Emerging Markets

This study performs a new investigation into determinants of sovereign default with the purpose of developing a model that will predict sovereign debt default/rescheduling. Determining sovereign default probabilities is useful since they can be used to monitor financial vulnerability of emerging markets. The threat of possible default problems in emerging markets is often a source of financial market turbulence in both emerging markets and globally. The recent literature on the determinants of financial crises usually focuses on currency and banking crises and only indirectly on sovereign debt crises. We aim to fill this gap.

Furthermore, all major international banks and international investors use default probabilities in their pricing models for bonds and loans as well as credit risk management models to determine country risk exposure limits. According to the new version of the Basel Capital Accord (Basel Committee 2003) banks are allowed to use their internal credit ratings and associated default rates in determining their required regulatory capital against credit risk.

This study aims to answer the following questions: (1) What are the most important determinants of sovereign default/rescheduling? (2) How accurately those determinants predict sovereign default/rescheduling? (3) How to specify a model in order to predict sovereign default/rescheduling with a higher accuracy?

Modelling Sovereign Debt Rescheduling Probabilities in Emerging Markets