Sovereign rating transitions and the price of default risk in emerging markets

ABSTRACT This paper introduces an expected value estimator with “expert knowledge” ,to the ,robust estimation of sovereign ,rating transitions which ,are characterised by few ,observations. Our estimates of default premia within Mexican, Colombian and Brazilian Eurobond yield spreads provide a better ,fit than ‘cohort’ and continuous-time observation approaches. The analysis suggests that default risk accounted for a rather small ,share (decreasing with maturity) of the yield spreads for non-investment grade Colombian and Brazilian Eurobondsin 2003. This share increased while yield spreads fell during ,2003-2005 mainly ,due to non-default risk factors. Default and liquidity premia for investment-grade Mexican ,spreads both decreased at similar rates. JEL classification: G15, C11, F34 Keywords: Emerging markets, sovereign default, rating transitions, yield spreads, default premia ,,,,,,,,,,,, Corresponding author. Tel.: +44 (0) 789 99 016; fax: +44 (0) 113 343 4459. ,E-mail addresses: A.L.Audzeyeva@leeds.ac.uk; K.R.Schenk-Hoppe@leeds.ac.uk. ,2