Template-Type: ReDIF-Paper 1.0
Series: Tinbergen Institute Discussion Papers
Creation-Date: 2009-11-17
Number: 09-102/2
Author-Name: Falko Juessen
Author-Workplace-Name: TU Dortmund University
Author-Name: Ludger Linnemann
Author-Workplace-Name: TU Dortmund University
Author-Name: Andreas Schabert
Author-Workplace-Name: TU Dortmund University
Title: Default Risk Premia on Government Bonds in a Quantitative Macroeconomic Model
Abstract: This paper examines the pricing of public debt in a quantitative macroeconomic model with government default risk. Default may occur due to a fiscal policy that does not preclude a Ponzi game. When a build-up of public debt makes this outcome inevitable, households stop lending such that the government has to default. Interest rates on government bonds reflect expectations of this event. There may exist multiple bond prices compatible with a rational expectations equilibrium. We analyze the conditions under which expected default risk premia can quantitatively rationalize sizeable spreads on public bonds. Sovereign default risk premia turn out to emerge at either very high debt to output ratios, or if the variance of productivity shocks is large.
Classification-JEL: E62, G12, H6, E32
Keywords: Sovereign default, asset pricing, fiscal policy, government debt
File-Url: https://papers.tinbergen.nl/09102.pdf
File-Format: application/pdf
File-Size: 288232 bytes
Handle: RePEc:tin:wpaper:20090102