Economics, Econometrics and Finance
4 years ago

Sovereign default risk can now be forecasted accurately using Merton's model.

The Journal of Fixed Income
Forecasting Sovereign Default Risk with Merton’s Model
Johan Duyvesteyn, Martin Martens

Paper Summary

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Merton's model can help predict if a country might not be able to pay its debts. Changes in CDS spreads are linked to exchange rates and can give clues about default risk. CDS spreads react slower to changes in model outputs like default probability. This analysis can help forecast CDS spreads for countries.