Country Default Probabilities: Assessing and Backtesting
by Stefan Huschens of the Technische Universitšt Dresden,
September 1, 2006
Abstract: We address the problem how to estimate default probabilities for sovereign countries based on market data of traded debt. A structural Merton-type model is applied to a sample of emerging market and transition countries. In this context, only few and heterogeneous default probabilities are derived, which is problematic for backtesting. To deal with this problem, we construct likelihood ratio test statistics and quick backtesting procedures.
Keywords: Sovereign default, Country risk, Default probability, Likelihood ratio test, Backtesting.