A macrofinance view of US Sovereign CDS premiums

Lukas Schmid, Andres Schneider and Mikhail Chernov
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Lukas Schmid: Duke University
Andres Schneider: UCLA

No 432, 2016 Meeting Papers from Society for Economic Dynamics

Abstract: Premiums on US 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 US \emph{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 a tractable equilibrium macrofinance model of the US economy, in which the fiscal and monetary policy stance jointly endogenously determine nominal debt, taxes, inflation and growth. While US 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 US sovereign CDS.

Date: 2016
New Economics Papers: this item is included in nep-dge, nep-fmk and nep-mac
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Citations: View citations in EconPapers (4)

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Related works:
Journal Article: A Macrofinance View of U.S. Sovereign CDS Premiums (2020)
Working Paper: A Macrofinance View of U.S. Sovereign CDS Premiums (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed016:432

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