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Admissible Surplus Dynamics and the Government Debt Puzzle

Author

Listed:
  • Pierre Collin-Dufresne

    (Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute; and CEPR)

  • Julien Hugonnier

    (Ecole Polytechnique Fédérale de Lausanne;CEPR)

  • Elena Perazzi

    (Ecole Polytechnique Fédérale de Lausanne)

Abstract

Is it possible to reconcile the procyclical Government surplus dynamics with the `safe asset status' of sovereign Debt? In an arbitrage-free market, if the aggregate debt value satisfies a transversality condition that rules out `bubbles', then it should equal the present value of future government surpluses. This relation seems to fail when the surplus process is calibrated to historical data in the US (Jiang, Lustig, van Nieuwerburgh, and Xiolan (2022). However, we show that when the government issues only safe bonds in an incomplete but arbitrage-free market, then not all surplus processes are admissible in the sense that they are consistent with both the dynamic budget constraint and a transversality condition. We propose a class of admissible surplus processes that matches empirical properties of US government spending and tax claims without generating a `debt valuation puzzle.'

Suggested Citation

  • Pierre Collin-Dufresne & Julien Hugonnier & Elena Perazzi, 2023. "Admissible Surplus Dynamics and the Government Debt Puzzle," Swiss Finance Institute Research Paper Series 23-45, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp2345
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    Cited by:

    1. Jiang, Zhengyang & Lustig, Hanno & Van Nieuwerburgh, Stijn & Xiaolan, Mindy Z., 2026. "Manufacturing risk-free government debt," Journal of Financial Economics, Elsevier, vol. 176(C).

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    Keywords

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    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • 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
    • H6 - Public Economics - - National Budget, Deficit, and Debt

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