Several articles I've read in the last few weeks in the business press have stated in passing as if it were an objective fact that the bond market was pricing in a 50% or more risk of a Brazilian government default. And at the same time, the risk premium of Brazilian C Bonds over US Treasury bonds was 20% or more. So I assume these two things roughly correspond: a 20% country risk premium is roughly equal to a 50% expected risk of default. I seem to remember the same correspondence coming up in one form or another during the Argentina crisis, that a 20% premium was seen as the tipping point.
Now I was wondering if my understanding of what this implies is correct: namely that the market takes as a given that after a default, the value of these bonds won't go to zero, but will be worth a little more than half their face value. My reasoning is if these odds are all correct, over a long period of time, bonds like this will return their holders 44% on their investment (over and above a normal treasury return) over a two year period during which they'll also default. If the value went to zero, it'd be nuts to buy a bond with those expectations: you'd lose 56% on your investment. But if after the default the value of the bond fell to 56%, it would make perfect sense. And of course there is then room for differences in opinion on whether the real odds are better or worse than than 50%, which is all you need to make a market.
Is this roughly correct? If so, this seems to me to give even more support to the argument of "Norman Strong" in
http://www.leftbusinessobserver.com/HowToDefault.html
that a world where sovereign default was common would be no big deal: bondholders are already pricing it in and still making a market. (BTW, a little over 50% was precisely what Norman thought an aggressive defaulting country should shoot for, the best price at which they could hope to exchange their debt.)
It also seems to imply that everything above 56% that bondholders get through an enforced non-default is gravy beyond what they've already gotten paid for in returns -- a coercive double exaction that is, in the worst (and not uncommon) case, very close to being literally a double exaction. And one from poor countries to rich bondholders.
Michael