Default Risk and the Pricing of U.S. Sovereign Bonds

112 Pages Posted: 13 Jun 2018 Last revised: 3 Apr 2024

See all articles by Robert F. Dittmar

Robert F. Dittmar

Rice University

Alex Hsu

Georgia Institute of Technology - Scheller College of Business

Guillaume Roussellet

McGill University - Desautels Faculty of Management

Peter Simasek

Georgia Institute of Technology - Scheller College of Business

Date Written: December 22, 2023

Abstract

We examine the relative pricing of nominal Treasury bonds and Treasury inflation-protected securities (TIPS) in the presence of United States default risk. Hedged breakeven inflation (ILSBEI) is positively and significantly related to U.S. default risk, driven by correlation between shocks to default risk and both shocks to inflation swap premia and Treasury yields. To understand the mechanisms through which default risk is related to inflation swaps and sovereign yields, we estimate an affine term structure model to capture their joint dynamics. Our estimation implies that the interaction between inflation dynamics and default is the primary source of differential pricing.

Keywords: Treasury, TIPS, Breakeven Inflation, Default risk, Recovery rates

JEL Classification: E4, E6, G12

Suggested Citation

Dittmar, Robert F. and Hsu, Alex and Roussellet, Guillaume and Simasek, Peter, Default Risk and the Pricing of U.S. Sovereign Bonds (December 22, 2023). Georgia Tech Scheller College of Business Research Paper No. 18-20, Available at SSRN: https://ssrn.com/abstract=3185307 or http://dx.doi.org/10.2139/ssrn.3185307

Robert F. Dittmar (Contact Author)

Rice University ( email )

6100 South Main Street
P.O. Box 1892
Houston, TX 77005-1892
United States

Alex Hsu

Georgia Institute of Technology - Scheller College of Business ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States
4043851123 (Phone)

Guillaume Roussellet

McGill University - Desautels Faculty of Management ( email )

1001 Sherbrooke St. West
Montreal, Quebec H3A1G5 H3A 2M1
Canada

Peter Simasek

Georgia Institute of Technology - Scheller College of Business ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States

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