PT  - JOURNAL ARTICLE
AU  - Ajax Moreira
AU  - Katia Rocha
TI  - Two-Factor Structural Model of Determinants of Brazilian Sovereign Risk
AID  - 10.3905/jfi.2004.419574
DP  - 2004 Jun 30
TA  - The Journal of Fixed Income
PG  - 48--59
VI  - 14
IP  - 1
4099  - https://pm-research.com/content/14/1/48.short
4100  - https://pm-research.com/content/14/1/48.full
AB  - A two-factor credit risk structural model is based on the contingent claims approach for pricing Brazilian sovereign risk implicit in the Brazilian government bond. Default probability is captured by two variables: the observed macroeconomic fundamental that triggers default, and the unobserved agents' expectation, identified as the risk premium evolving smoothly over time. Applications of the model include establishing the effect of the country's indebtedness level for different credit spreads; estimating the default probability and the associated risk premium; and forecasting the credit spread. The model shows forecasting ability. Both fundamentals and expectations are significant in explaining the credit spread evolution, and the time-varying risk premium suggests latitude to reduce the credit spread as a consequence of an improvement in expectations rather than fundamentals.