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

This paper introduces an expected value estimator with expert knowledge to the robust estimation of sovereign rating transitions which are characterised by few observations. Ourestimates 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 Eurobonds in 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.