Pricing Contract Terms in a Crisis: Venezuelan Bonds in 2016

Abstract

As of this writing in June 2016, the markets are predicting Venezuela to be on the brink of default. On June 1, 2016, the 6 month CDS contract traded at about 7000bps which translates into a likelihood of default of over 90%. Our interest in the Venezuelan crisis is that its outstanding sovereign bonds have a unique set of contractual features that, in combination with its near-default status, have created a natural experiment. This experiment has the potential to shed light on one of the long standing questions that sits at the intersection of the fields of law and finance, the question of the degree to which financial markets price contract terms. We find evidence to suggest that at least within the confines of a near-default scenario, the markets are highly sensitive to even small differences in contract language.

Keywords: efficient markets, contracts, bonds, sovereign debt, collective action clauses, pari passu

JEL Classification: F34, H63, H74, H81, K12