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A Macrofinance View of U.S. Sovereign CDS Premiums

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  • Chernov, Mikhail
  • Schmid, Lukas
  • Schneider, Andres

Abstract

Premiums on U.S. sovereign CDS have risen to persistently elevated levels since the financial crisis. In this paper, we ask whether these premiums reflect the probability of a U.S. fiscal default, namely a state in which budget balance can no longer be restored by further raising taxes or eroding the real value of debt by raising inflation. To that end, we develop an equilibrium macrofinance model of the U.S. economy, in which the fiscal and monetary policy stance jointly endogenously determine nominal debt, taxes, inflation and growth. While U.S. CDS cannot be valued using standard replication arguments, we show how in our equilibrium model, CDS premiums reflect endogenous risk adjusted fiscal default probabilities. A calibrated version of the model is quantitatively consistent with high premiums on U.S. sovereign CDS.

Suggested Citation

  • Chernov, Mikhail & Schmid, Lukas & Schneider, Andres, 2016. "A Macrofinance View of U.S. Sovereign CDS Premiums," CEPR Discussion Papers 11576, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:11576
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    References listed on IDEAS

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    More about this item

    Keywords

    credit default swaps; recursive preferences; sovereign default;

    JEL classification:

    • 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
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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