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We develop a pricing model for Sovereign Contingent Convertible bonds (S-CoCo) with payment standstills triggered by a sovereign’s Credit Default Swap (CDS) spread. We model CDS spread regime switching, which is prevalent during crises, as a hidden Markov process, coupled with a mean-reverting stochastic process of spread levels under fixed regimes, in order to obtain S-CoCo prices through simulation. The paper uses the pricing model in a Longstaff–Schwartz American option pricing framework to compute future state contingent S-CoCo prices for risk management. Dual trigger pricing is also discussed using the idiosyncratic CDS spread for the sovereign debt together with a broad market index. Numerical results are reported using S-CoCo designs for Greece, Italy and Germany with both the pricing and contingent pricing models.

In this paper, we derive a cost-minimizing approach for governments in the eurozone that have to define their debt structure in terms of currency of issuance and maturity. We introduce and characterize the concept of weighted coalitional $\alpha$-equilibrium to assure stability of two tiers of the eurozone, the stronger (White) countries and the weaker (Yolk) countries. The equilibrium presents both the Pareto optimality of the countries in each tier and the stability against any deviation of each subcoalition. In a practical way, it would require either strong political integration within each tier or considerable market pressure.

The arguments put forward by Bulow and Rogoff [Brookings Papers on Economic Activity, 2 (1988) 675; Quarterly Journal of Economics, 106 (1991) 1219] against sovereign debt buybacks are re-examined in a willingness-to-pay framework. This paper argues that the Bulow–Rogoff framework treats default by a debtor as an event with no dead-weight loss, and, as such, underestimates the potential gains from a buyback. The willingness-to-pay framework allows dead-weight costs of default to be introduced in a consistent and simple fashion into the buybacks calculus. Two versions of this framework are considered. First, a model in which the default costs induce an all-or-nothing default decision is analyzed. In this case, an ambiguous result is derived in which the variability of the debtor's income determines whether (small) buybacks are beneficial to the debtor, even though expected total transfers to the creditor increase, consistent with Bulow–Rogoff. In a second version, default costs are modeled so as to induce at most a partial default. This model corresponds most closely, in terms of the repayment behavior of the sovereign debtor, to the models used by Bulow and Rogoff. It is shown that small buybacks are always beneficial to the debtor in this case. The second version is extended to include an investment opportunity. Only if the country has sufficiently scarce resources when the investment can be made will a buyback be harmful to the interests of the debtor.

A model of a sovereign debt restructuring process, consistent with existing legal contracts, institutions and financial market practices, was designed and tested with major investors and government officials playing their real life roles on November 3, 2001, approximately 7 weeks prior to the default by the government of Argentina. The results demonstrated that a set of market-based rules could be implemented that would achieve an orderly debt restructuring without contagion and without significant official financing within the existing institutional framework.

This paper analyzes the extent to which selection explains the observed discrepancy between solicited and unsolicited ratings. I propose a model of selection with truth telling rating agencies and borrowers with the ability to veto the revelation of the rating. The observed difference between the two categories of ratings in different sectors is in line with the prediction of the model. In the sovereign market there is a positive selection of borrowers into unsolicited ratings whereas other sectors have, on the contrary, lower unsolicited rating grades than those solicited.

This paper identifies, quantifies, and assesses fiscal risks in Bangladesh. By performing sensitivity analysis and using stochastic simulations, it measures risks arising from shocks to gross domestic product growth, the exchange rate, commodity prices, and interest rates. It also analyzes specific fiscal and institutional risks, including those related to the pension system, issuance of guarantees, state-owned commercial banks, and external borrowing and debt management strategies. The paper finds that fiscal aggregates are particularly sensitive to shocks to commodity prices and the exchange rate. Other factors that could affect fiscal aggregates are the unfunded pension system and limited institutional capacity.

The Contingent Claims Analysis (CCA) is a general approach to analyze the stakeholders of a corporation who have contingent claims on the future, uncertain cash-flows generated by the operations of the firms. The CCA allows valuing each stakeholder’s claim and also to assess the risk incurred by the stakeholders. The CCA highlights the potential conflicts of interest among the various claimholders. In this paper, we review applications of CCA including valuation of various forms of debt, rating, credit spread, probability of default and corporate events like dividends, employee stock options and M&A. The CCA framework is shown to be useful to address all these financial questions. In this approach the starting point is that the value and the risk of the firm’s assets are given. The future distribution of the assets’ rates of return is also known and given. The focus is on the liability side of the balance sheet, i.e., the funding sources of the activity of the firm, and more generally on the financial claims of the various claimholders of the firm.

The credit default swap (CDS) market has experienced tremendous changes over the last two decades. This chapter reviews recent studies on the CDS contract and the CDS market, highlighting recent developments in CDS contracts and market structures. Characteristics of CDS contracts make them outstanding from other derivatives products, and the rapid development of CDS markets shows the popular use and importance of CDS contracts in general. Policies and regulations on CDSs have brought huge changes to the market and the availability of publicly reported data. The relationship between firms and CDS has long been a focus among academics. Moreover, CDSs are also commonly used among mutual funds, hedge funds, and banks, affecting the trading activities of various financial intermediaries. While the sovereign CDS and index CDS are shown to be more and more significant in financial markets, other CDS products, including CDS options and tranches, also experience changes. We summarize the evolution in CDS markets and the structure of CDS studies, aiming to gain a better understanding of CDS markets and provide insights for future studies on the CDS market.