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Government debt and risk premia

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  • Liu, Yang

Abstract

Risk premia increase with government debt. Debt-to-GDP ratios positively predict stock returns at short and long horizons in the U.S. and other advanced economies. Higher debt is also associated with higher bond premia and lower risk-free rates. Major government debt theories (liquidity, safety, crowding out) either do not address or are inconsistent with these findings. New evidence suggests that the increased risk premia provide compensation for larger fiscal risk; during periods of elevated debt, fiscal policy becomes more uncertain and less effective and can lead to debt crises. I quantify these mechanisms in an equilibrium model.

Suggested Citation

  • Liu, Yang, 2023. "Government debt and risk premia," Journal of Monetary Economics, Elsevier, vol. 136(C), pages 18-34.
    • Handle: RePEc:eee:moneco:v:136:y:2023:i:c:p:18-34
    DOI: 10.1016/j.jmoneco.2023.01.009
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    More about this item

    Keywords

    Government debt; Risk premia; Fiscal policy risk;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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