1. Sovereign risk and the Euro: lessons from the crisis
Loss Given What? Open Issues in Loss Severity Analysis in Sovereign Crises
Umberto Cherubini
Sovereign risk and the Euro: lessons from the crisis
Bologna, October

2. Sovereign Credit Spreads: A Bail-out Model with PSI
Angelo S. Baglioni – Umberto Cherubini or

3. Outline Definitions of LGD for corporate and sovereign
Recovery rate of what?
Deterministic and stochastic exposure
LGD with bail-out and PSI (private sector involvment)
Determination of the bail-out threshold
Determination of the PSI
Redenomination risk and LGR
Redenomination probability models
Loss Given Redenomination (no model available)

4. Recovery of what? Recovery of face value: Recovery of treasury:
3. Recovery of market value:

5. Argentina debt swap bonds
Type: Discount
Market price:
Risk free:
EL (Face): 67.46
EL (Treasury): 87.22
Value (Face): 83.66
Value (Trs): 63.91
Recovery: 21.92%
Type: Par
Market price: 31.25
Risk free: 91.22
EL (Face): 64.50
EL (Treasury): 59.22
Value (Face): 26.73
Value (Trs): 32.00
Recovery: 21.92%

6. Sovereign risk with bail-out
Assume at time of default  of a country of the area Euro its amount F( ) of debt is written down to a level Fk.
Fk is a bail-out threshold, in the sense that starting from that level, the EMS would provide funding at the risk-free rate.
The amount of debt is typically written in terms of GDP. Denote f( ) the value of debt in terms of GDP and fk the corresponding bail-out threshold in terms of GDP.

7. Bail-out and Private Sector Involvement (PSI)
If In case of default there bail-out is expected for the an amount of debt equal to fK of GDP, the loss to private investors (PSI) is represented by a sequence of exchange options

8. A simple model specification
Consider a GBM dynamics for GDP
and a model with jumps for debt
with s primary surplus, r interest rate and c excess interest expenses

9. Margrabe formula
Given the structure of the model, the value of PSI is simply given by Margrabe formula

10. The bail-out threshold
The bail-out threshold can be simply defined as the level from which debt converge, once given risk-free funding, to a value equal or lower than the target level, that for Europe is considered 60%, with a confidence level of probability .

18. Debt threshold

19. Redenomination risk
A peculiar risk of the crisis has been redenomination risk, that was about to materialize during the Greek crisis, and this confirmed by recent statements by the alleged new German finance minister.
Suggested estimation techniques for redenomination probability
CDS denominated in dollars vs CDS denominated in euros (De Santis. 2016)
ADR denominated in dollars and euros (Eichler and Rövekamp, 2017)
Models for Loss Given Redenomination
No model available to the best of our knowledge.
The task is to simulate the path of monetary policy, term structure and inflation.

20. Default and redenomination risk

21. Collective action clause

22. The CAC option