What does the CDS market imply for a U.S. default?

Luca Benzoni, Christian Cabanilla, Alessandro Cocco and Cullen Kavoussi
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Alessandro Cocco: https://www.chicagofed.org/people/c/cocco-alessandro

No WP 2023-17, Working Paper Series from Federal Reserve Bank of Chicago

Abstract: As the debt ceiling episode unfolds, we highlight a sharp increase in trading activity and liquidity in the U.S. credit default swaps (CDS) market, as well as a spike in U.S. CDS premiums. Compared with the periods leading up to the 2011 and 2013 debt ceiling episodes, we show that elevated CDS spreads in the current environment are partially explained by the cheapening of deliverable Treasury collateral to CDS contracts. We infer the likelihood of a U.S. default from these CDS premiums, and estimate an increase in the market-implied default probability from about 0.3–0.4% in 2022, to around 4% in April 2023, which is lower than it was in July 2011 and about where it was in October 2013. Finally, we document changes in Treasury bills trading activity as market participant update their expectations for a U.S. default.

JEL-codes: E32 E43 E44 G10 G12 G18 G28 (search for similar items in EconPapers)
Pages: 19
Date: 2023-05-17
New Economics Papers: this item is included in nep-ban and nep-fmk
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