Hostname: page-component-cd9895bd7-mkpzs Total loading time: 0 Render date: 2024-12-28T10:53:04.206Z Has data issue: false hasContentIssue false
  • English
  • Français

DEFAULT RISK PREMIA ON GOVERNMENT BONDS IN A QUANTITATIVE MACROECONOMIC MODEL

Published online by Cambridge University Press:  16 September 2014

Falko Juessen ,
Ludger Linnemann  and
Andreas Schabert
Falko Juessen
Affiliation:
Bergische Universitaet Wuppertal and IZA
Ludger Linnemann
Affiliation:
TU Dortmund University
Andreas Schabert*
Affiliation:
University of Cologne
*
Address correspondence to: Andreas Schabert, University of Cologne, Center for Macroeconomic Research, Albertus-Magnus-Platz, 50923 Cologne, Germany; e-mail: [email protected].
Get access Rights & Permissions [Opens in a new window]

Abstract

We develop a macroeconomic model in which the government does not guarantee to repay debt. We ask whether movements in the price of government bonds can be rationalized by lenders' unwillingness to fully roll over debt when the outstanding level of debt exceeds the government's repayment capacity. Investors do not support a Ponzi game in this case, but ration credit supply, thus forcing default at an endogenously determined fractional repayment rate. Interest rates on government bonds reflect expectations of this event. Numerical results show that default premia can emerge at moderately high debt-to-GDP ratios where even small changes in fundamentals lead to steeply rising interest rates. The behavior of risk premia broadly accords with recent observations for several European countries that experienced a worsening of fundamental fiscal conditions.

Keywords

Sovereign DefaultFiscal PolicyGovernment Debt
Type
Articles
Information
Macroeconomic Dynamics , Volume 20 , Issue 1 , January 2016 , pp. 380 - 403
Copyright
Copyright © Cambridge University Press 2014 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

REFERENCES

Arellano, Cristina (2008) Default risk and income fluctuations in emerging economies. American Economic Review 98, 690–712.CrossRefGoogle Scholar
Auerbach, Alan J., Gokhale, Jagadeesh, and Kotlikoff, Laurence J. (1994) Generational accounting: A meaningful way to evaluate fiscal policy. Journal of Economic Perspectives 8, 73–94.CrossRefGoogle Scholar
Bi, Huixin (2012) Sovereign default risk premia, fiscal limits, and fiscal policy. European Economic Review 56, 389–410.CrossRefGoogle Scholar
Bi, Huixin and Leeper, Eric (2012) Analyzing Fiscal Sustainability. Unpublished manuscript, Indiana University.Google Scholar
Bohn, Henning (1998) The behavior of U.S. public debt and deficits. Quarterly Journal of Economics 113, 949–963.CrossRefGoogle Scholar
Daniel, Betty C. and Shiamptanis, Christos (2012) Fiscal risk in a monetary union. European Economic Review 56, 1289–1309.CrossRefGoogle Scholar
D'Erasmo, Pablo and Mendoza, Enrique G. (2013) Distributional incentives in an equilibrium model of domestic sovereign default. NBER working paper 19477.Google Scholar
Eaton, Jonathan and Gersovitz, Mark (1981) Debt with potential repudiation: Theoretical and empirical analysis. Review of Economic Studies 47, 289–309.CrossRefGoogle Scholar
Evans, Richard W., Kotlikoff, Lawrence J., and Phillips, Kerk L. (2013) Game over: Simulating unsustainable fiscal policy. In Alesina, A. and Giavazzi, F. (eds.), Fiscal Policy After the Financial Crisis, pp. 177–202. Chicago: University of Chicago Press.Google Scholar
Lorenzoni, Guido and Werning, Ivan (2013) Slow Moving Debt Crises. Unpublished manuscript, Northwestern University.CrossRefGoogle Scholar
Mendoza, Enrique G. and Yue, Vivian Z. (2012) A general equilibrium model of sovereign default and business cycles. Quarterly Journal of Economics 127, 889–946.CrossRefGoogle Scholar
Reinhart, Carmen and Rogoff, Kenneth (2008) The Forgotten History of Domestic Debt. NBER working paper 13946.CrossRefGoogle Scholar
Schabert, Andreas (2010) Monetary policy under a fiscal theory of sovereign default. Journal of Economic Theory 145, 860–868.CrossRefGoogle Scholar
Sims, Christopher (1994) A simple model for the study of the determination of the price level and the interaction of monetary and fiscal policy. Economic Theory 4, 381–399.CrossRefGoogle Scholar
Tauchen, George (1986) Finite state Markov-chain approximation to univariate and vector autoregressions. Economics Letters 20, 177–181.CrossRefGoogle Scholar
Uribe, Martin (2006) A fiscal theory of sovereign risk. Journal of Monetary Economics 53, 1857–1875.CrossRefGoogle Scholar
Woodford, Michael (1994) Monetary policy and price level determinacy in a cash-in-advance economy. Economic Theory 4, 345–380.CrossRefGoogle Scholar