Working Paper: CEPR ID: DP2866
Authors: Robert Cumby; Tuvana Pastine
Abstract: We investigate the pricing of ?Brady? bonds that are issued by the governments of five developingcountries as part of debt and debt service reduction agreements. We first present a measure of creditquality that takes account of the individual features of each bond and is comparable across bonds,across issuers, and over time. We then examine the evolution of the credit quality of each debtinstrument from 1990 until the beginning of 2000. Next, we present evidence of a profitable tradingstrategy that exploits the information contained in this measure of credit quality.
Keywords: Brady Bonds; Default Risk; Market Efficiency; Mispricing; Sovereign Debt
JEL Codes: F32; F34; G14; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| prices of Brady bonds (E43) | implied default probabilities (G33) |
| differences in implied default probabilities across bonds issued by the same borrower (H74) | pricing errors (D49) |
| implied default probabilities (G33) | pricing differences (D49) |
| trading strategies based on implied default probabilities (G13) | profitability (L21) |
| observed pricing differences (D40) | temporary mispricing (D49) |
| implied default probabilities (G33) | assessment of credit quality (G32) |