A Macrofinance View of U.S. Sovereign CDS Premiums

Mikhail Chernov, Lukas Schmid and Andres Schneider

No 11576, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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.

Keywords: Sovereign default; Credit default swaps; Recursive preferences (search for similar items in EconPapers)
JEL-codes: E43 E44 E52 G12 G13 (search for similar items in EconPapers)
Date: 2016-10
New Economics Papers: this item is included in 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 US Sovereign CDS premiums (2016)
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