Admissible Surplus Dynamics and the Government Debt Puzzle

Pierre Collin-Dufresne, Julien Hugonnier and Elena Perazzi
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Pierre Collin-Dufresne: Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute; and CEPR
Elena Perazzi: Ecole Polytechnique Fédérale de Lausanne

No 23-45, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

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.'

Keywords: Government debt; sustainability; government surplus; transversality condition (search for similar items in EconPapers)
JEL-codes: E44 E62 G12 H6 (search for similar items in EconPapers)
Pages: 54 pages
Date: 2023-06
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Related works:
Working Paper: Admissible Surplus Dynamics and the Government Debt Puzzle (2024)
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp2345

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