Default and Recovery Implicit in the Term Structure of Sovereign CDS Spreads


  • JUN PAN,


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    • Pan is with the MIT Sloan School of Management and NBER. Singleton is with the Graduate School of Business, Stanford University and NBER. We have benefited from discussions with Antje Berndt, Darrell Duffie, Michael Johannes, Jun Liu, Francis Longstaff, Roberto Rigobon; seminar participants at Chicago, Columbia, CREST, Duke, USC, UCLA, University of Michigan, the 2005 NBER IASE workshop, the November 2005 NBER Asset Pricing meeting, the 2006 AFA Meetings, AQR, the 2007 Fed conference on credit risk and credit derivatives; and the comments of two anonymous referees. Scott Joslin provided excellent research assistance. We are grateful for financial support from the Gifford Fong Associates Fund at the Graduate School of Business, Stanford University and from the MIT Laboratory for Financial Engineering.


This paper explores the nature of default arrival and recovery implicit in the term structures of sovereign CDS spreads. We argue that term structures of spreads reveal not only the arrival rates of credit events (λ), but also the loss rates given credit events. Applying our framework to Mexico, Turkey, and Korea, we show that a single-factor model with λ following a lognormal process captures most of the variation in the term structures of spreads. The risk premiums associated with unpredictable variation in λ are found to be economically significant and co-vary importantly with several economic measures of global event risk, financial market volatility, and macroeconomic policy.