Extracting Default Probabilities from Sovereign Bonds ∗

Sovereign risk analysis is central in debt markets. Considering different bonds and countries, there are innumerous measures aiming to identify the way risk is perceived by market participants. In such environment, probabilities of default play a central role on investors decisions. This article contributes with a parametric arbitrage-free dynamic model to estimate defaultable term structures of sovereign bonds. The proposed model builds on Duffie and Singleton’s (1999) general reduced-form model by proposing a piecewise constant struc-ture for the conditional probabilities of defaults. Once fixed an av-erage recovery rate value for the whole market, the proposed model estimates implied probabilities of defaults from bond prices, working as a parsimonious tool to quantify investor’s perception of credit risk. We apply this methodology to analyze the behavior of default prob-abilities within the Brazilian sovereign fixed income market on three different recent economic moments