Premium
A Macrofinance View of U.S. Sovereign CDS Premiums
Author(s) -
CHERNOV MIKHAIL,
SCHMID LUKAS,
SCHNEIDER ANDRES
Publication year - 2020
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/jofi.12948
Subject(s) - economics , credit default swap , sovereign default , monetary economics , inflation (cosmology) , debt , value (mathematics) , fiscal policy , risk premium , probability of default , bond , credit risk , sovereignty , sovereign debt , macroeconomics , finance , physics , machine learning , politics , political science , theoretical physics , computer science , law
Premiums on U.S. sovereign credit default swaps (CDS) have risen to persistently elevated levels since the financial crisis. We examine whether these premiums reflect the probability of a fiscal default—a state in which a balanced budget can no longer be restored by raising taxes or eroding the real value of debt by increasing inflation. We develop an equilibrium macrofinance model in which the fiscal and monetary policy stances jointly endogenously determine nominal debt, taxes, inflation, and growth. We show that the CDS premiums reflect the endogenous risk‐adjusted probabilities of fiscal default. The calibrated model is consistent with elevated levels of CDS premiums but leaves dynamic implications quantitatively unresolved.