Default Risk Premia on Government Bonds in a Quantitative Macroeconomic Model
AbstractThis paper examines the pricing of public debt in a quantitative macroeconomic model with government default risk. Default may occur due to a fiscal policy that does not preclude a Ponzi game. When a build-up of public debt makes this outcome inevitable, households stop lending such that the government has to default. Interest rates on government bonds reflect expectations of this event. There may exist multiple bond prices compatible with a rational expectations equilibrium. We analyze the conditions under which expected default risk premia can quantitatively rationalize sizeable spreads on public bonds. Sovereign default risk premia turn out to emerge at either very high debt to output ratios, or if the variance of productivity shocks is large.
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Bibliographic InfoPaper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 09-102/2.
Date of creation: 17 Nov 2009
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Sovereign default; asset pricing; fiscal policy; government debt;
Find related papers by JEL classification:
- E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- H6 - Public Economics - - National Budget, Deficit, and Debt
- E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-05-15 (All new papers)
- NEP-MAC-2010-05-15 (Macroeconomics)
- NEP-RMG-2010-05-15 (Risk Management)
- NEP-UPT-2010-05-15 (Utility Models & Prospect Theory)
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