How does the Bond Market Perceive Government Interventions?
69 Pages Posted: 10 Mar 2010 Last revised: 15 Mar 2013
Date Written: March 1, 2013
The ongoing threat of the U.S. public sector sliding over the 'fiscal cliff' urges financial economists to better understand the foundations for how government spending affects the real economy and financial markets. This paper is the first study to document that uncertainty about future government spending is a first-order risk factor in the bond market, leading to rising real and nominal interest rates, a steeper term spread, an increase in bond market volatility and bond premia. We study an equilibrium asset pricing model with a forward-looking representative agent and a forward-looking government to shed light on these empirical facts.
Keywords: policy uncertainty, fiscal multiplier, policy premium, option implied volatility, knightian ambiguity
JEL Classification: E43, E44, G12
Suggested Citation: Suggested Citation