Default Risk Premia on Government Bonds in a Quantitative Macroeconomic Model

Tinbergen Institute Discussion Paper No. 09-102/2

34 Pages Posted: 20 Nov 2009 Last revised: 21 Dec 2009

See all articles by Falko Juessen

Falko Juessen

University of Dortmund - Department of Economics; IZA Institute of Labor Economics

Ludger Linnemann

University of Dortmund

Andreas Schabert

University of Cologne - Department of Economics; University of Dortmund; University of Amsterdam - Faculty of Economics and Business

Date Written: November 17, 2009

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.

Keywords: sovereign default, asset pricing, fiscal policy, government debt

JEL Classification: E62, G12, H6, E32

Suggested Citation

Juessen, Falko and Linnemann, Ludger and Schabert, Andreas, Default Risk Premia on Government Bonds in a Quantitative Macroeconomic Model (November 17, 2009). Tinbergen Institute Discussion Paper No. 09-102/2. Available at SSRN: https://ssrn.com/abstract=1507676 or http://dx.doi.org/10.2139/ssrn.1507676

Falko Juessen (Contact Author)

University of Dortmund - Department of Economics ( email )

D-44221 Dortmund
Germany

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Ludger Linnemann

University of Dortmund ( email )

Department of Economics
Dortmund, D-44221
Germany

Andreas Schabert

University of Cologne - Department of Economics ( email )

Cologne, 50923
Germany

University of Dortmund ( email )

Vogelpothsweg 87
Dortmund, 44227
Germany
+49 231 755 3288 (Phone)

University of Amsterdam - Faculty of Economics and Business ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands

Register to save articles to
your library

Register

Paper statistics

Downloads
121
Abstract Views
760
rank
236,810
PlumX Metrics