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Default Risk Premia on Government Bonds in a Quantitative Macroeconomic Model

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  • Falko Juessen

    (TU Dortmund University)

  • Ludger Linnemann

    (TU Dortmund University)

  • Andreas Schabert

    (TU Dortmund University)

Abstract

This 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 Info

Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 09-102/2.

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Date of creation: 17 Nov 2009
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Handle: RePEc:dgr:uvatin:20090102

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Web page: http://www.tinbergen.nl

Related research

Keywords: Sovereign default; asset pricing; fiscal policy; government debt;

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Cited by:
  1. Eric M. Leeper & Todd B. Walker, 2011. "Fiscal Limits in Advanced Economies," Economic Papers, The Economic Society of Australia, vol. 30(1), pages 33-47, 03.
  2. Huixin Bi & Eric M. Leeper, 2013. "Analyzing Fiscal Sustainability," Working Papers 13-27, Bank of Canada.
  3. Roland Döhrn & György Barabas & Heinz Gebhardt & Tobias Kitlinski & Martin Micheli & Torsten Schmidt & Simeon Vosen & Lina Zwick, 2012. "Die wirtschaftliche Entwicklung im Inland: Gedämpfte Expansion bei hohen Risiken," RWI Konjunkturbericht, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, pages 57, 09.
  4. Bi, Huixin, 2012. "Sovereign default risk premia, fiscal limits, and fiscal policy," European Economic Review, Elsevier, vol. 56(3), pages 389-410.
  5. Oguro, Kazumasa & Sato, Motohiro, 2011. "Public Debt Accumulation and Fiscal Consolidation," CIS Discussion paper series 517, Center for Intergenerational Studies, Institute of Economic Research, Hitotsubashi University.

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