A Macrofinance View of U.S. Sovereign CDS Premiums
Corresponding Author
MIKHAIL CHERNOV
Correspondence: Mikhail Chernov, UCLA Anderson School of Management, 110 Westwood Plaza, Suite C-417, Los Angeles, CA 90095; email: mikhail.chernov@anderson.ucla.edu.
Search for more papers by this authorLUKAS SCHMID
Search for more papers by this authorANDRES SCHNEIDER
Mikhail Chernov is with UCLA, NBER, and CEPR. Lukas Schmid is with USC and CEPR, and Andres Schneider is with the Federal Reserve Board. We wish to thank the Editor, Stefan Nagel, and the two referees for the helpful feedback. We also thank Patrick Augustin, Ric Colacito, Tim Johnson, Arvind Krishnamurthy, David Lando, Hanno Lustig, Batchimeg Sambalaibat, Martin Schmalz, Adrien Verdelhan, and Paul Whelan for comments on earlier drafts of this paper. We are also grateful for feedback received from participants at the 2016 BI-SHoF conference, Mannheim Asset Pricing Conference, 2016 NBER Summer Institute, 2016 SED meetings, 2016 SITE meeting, 2016 SFS Cavalcade, 2015 Tepper/LAEF macrofinance conference, and 2016 WFA meetings, as well as at seminars at Baruch College, Boston University, the Chinese University of Hong Kong, City University of Hong Kong, Nanyang Technological University, National University of Singapore, Singapore Management University, Federal Reserve Board, University of Michigan, University of Zurich, University of Illinois Urbana-Champaign, and University of Montreal. The views expressed herein are those of the authors and do not necessarily reflect the position of the Board of Governors of the Federal Reserve or the Federal Reserve System. We have read The Journal of Finance disclosure policy and have no conflicts of interest to disclose.
Search for more papers by this authorCorresponding Author
MIKHAIL CHERNOV
Correspondence: Mikhail Chernov, UCLA Anderson School of Management, 110 Westwood Plaza, Suite C-417, Los Angeles, CA 90095; email: mikhail.chernov@anderson.ucla.edu.
Search for more papers by this authorLUKAS SCHMID
Search for more papers by this authorANDRES SCHNEIDER
Mikhail Chernov is with UCLA, NBER, and CEPR. Lukas Schmid is with USC and CEPR, and Andres Schneider is with the Federal Reserve Board. We wish to thank the Editor, Stefan Nagel, and the two referees for the helpful feedback. We also thank Patrick Augustin, Ric Colacito, Tim Johnson, Arvind Krishnamurthy, David Lando, Hanno Lustig, Batchimeg Sambalaibat, Martin Schmalz, Adrien Verdelhan, and Paul Whelan for comments on earlier drafts of this paper. We are also grateful for feedback received from participants at the 2016 BI-SHoF conference, Mannheim Asset Pricing Conference, 2016 NBER Summer Institute, 2016 SED meetings, 2016 SITE meeting, 2016 SFS Cavalcade, 2015 Tepper/LAEF macrofinance conference, and 2016 WFA meetings, as well as at seminars at Baruch College, Boston University, the Chinese University of Hong Kong, City University of Hong Kong, Nanyang Technological University, National University of Singapore, Singapore Management University, Federal Reserve Board, University of Michigan, University of Zurich, University of Illinois Urbana-Champaign, and University of Montreal. The views expressed herein are those of the authors and do not necessarily reflect the position of the Board of Governors of the Federal Reserve or the Federal Reserve System. We have read The Journal of Finance disclosure policy and have no conflicts of interest to disclose.
Search for more papers by this authorABSTRACT
Premiums on U.S. sovereign credit default swaps (CDS) have risen to persistently elevated levels since the financial crisis. We examine whether these premiums reflect the probability of a fiscal default—a state in which a balanced budget can no longer be restored by raising taxes or eroding the real value of debt by increasing inflation. We develop an equilibrium macrofinance model in which the fiscal and monetary policy stances jointly endogenously determine nominal debt, taxes, inflation, and growth. We show that the CDS premiums reflect the endogenous risk-adjusted probabilities of fiscal default. The calibrated model is consistent with elevated levels of CDS premiums but leaves dynamic implications quantitatively unresolved.
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