The U.S. Public Debt Valuation Puzzle
69 Pages Posted: 24 Dec 2019 Last revised: 19 Feb 2023
Date Written: December 2019
The government budget constraint ties the market value of government debt to the expected risk-adjusted present discounted value of fiscal surpluses. We find evidence that U.S. Treasury investors fail to impose this no-arbitrage restriction in the U.S. Both cyclical and long-run dynamics of tax revenues and government spending make the surplus claim risky. In a realistic asset pricing model, this risk in surpluses creates a large gap between the market value of debt and its fundamental value, the PDV of surpluses, suggesting that U.S. Treasurys may be mispriced.
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