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Benchmark interest rates when the government is risky

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  • Augustin, P.
  • Chernov, M.
  • Schmid, L.
  • Song, D.

Abstract

Since the global financial crisis, interest rate swap rates, which represent future uncollateralized interbank borrowing, have fallen below maturity-matched Treasury rates. This is surprising, because US Treasuries, which are deemed expensive because of superior liquidity and safety, should produce yields that are lower than those of swap rates. We show, by no-arbitrage, that sovereign default risk explains negative swap spreads even without frictions such as balance sheet constraints, convenience yield, and hedging demand. We support this explanation with an equilibrium model that jointly accounts for macroeconomic fundamentals and the term structures of interest and US credit default swap rates.

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  • Augustin, P. & Chernov, M. & Schmid, L. & Song, D., 2021. "Benchmark interest rates when the government is risky," Journal of Financial Economics, Elsevier, vol. 140(1), pages 74-100.
  • Handle: RePEc:eee:jfinec:v:140:y:2021:i:1:p:74-100
    DOI: 10.1016/j.jfineco.2020.10.009
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    Cited by:

    1. David-Pur, Lior & Galil, Koresh & Rosenboim, Mosi, 2020. "The dynamics of sovereign yields over swap rates in the Eurozone market," International Review of Financial Analysis, Elsevier, vol. 72(C).

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    More about this item

    Keywords

    Sovereign credit risk; Negative swap rates; Recursive preferences; Term structure;
    All these keywords.

    JEL classification:

    • C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • H60 - Public Economics - - National Budget, Deficit, and Debt - - - General

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