Default Recovery Rates and Implied Default Probability Estimations: Evidence from the Argentinean Crisis

This paper applies the model presented by J. Merrick Jr. (2001) to estimate both the default recovery rates and the implied default probabilities of the Argentinean Sovereign Bonds during the crisis which took place in December 2001. Between October 19th and December 24th 2001, the average bond price level re�ected a downward trend, falling from USD 56.8 to USD 26.5 for each USD 100 face value. Similarly, default recovery rates descended from USD 38.7 to USD 20.8 whereas the base default probability registered an increase from 19.4% to 45.5%. Thus, bond price volatility could be explained in terms of these two embedded determinants. According to the model, bond prices were overvalued by USD 3.92 on average, which amounts to 12.9%; even when it is generally assumed that the default was foreseen by the market in December 2001. In accordance with private estimations of the Argentinean debt haircut which set it at 70% and the recovery rate estimated by the model which amounts to USD 21.7, Argentina would have overcome its default with a country risk premium of around 1960 basic points. Such a high country risk spread after debt restructuring would fully justify a deep haircut over the face value, the temporal term structure and interest rate coupons.