Manufacturing Risk-free Government Debt

65 Pages Posted: 8 Jul 2020 Last revised: 17 Jun 2021

See all articles by Zhengyang Jiang

Zhengyang Jiang

Kellogg School of Management - Department of Finance

Hanno N. Lustig

Stanford Graduate School of Business; National Bureau of Economic Research (NBER)

Stijn Van Nieuwerburgh

Columbia University Graduate School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); ABFER

Mindy Z. Xiaolan

University of Texas, Austin - Department of Finance

Multiple version iconThere are 4 versions of this paper

Date Written: June 17, 2021

Abstract

Governments face a trade-off between insuring bondholders and insuring taxpayers against output shocks. If they insure bondholders by manufacturing risk-free zero-beta debt, then they can only provide limited insurance to taxpayers. Taxpayers will pay more taxes in bad times regardless of whether output shocks are permanent or temporary. Permanent shocks impute long-run output risk to the debt while transitory shocks impute interest rate risk, all of which must be offset through taxation to keep the debt safe. Conversely, if governments insure taxpayers against adverse macro shocks, then the debt becomes risky. Convenience yields on government debt temporarily alleviate the trade-off.

Keywords: fiscal policy, bond pricing

JEL Classification: G12, E62

Suggested Citation

Jiang, Zhengyang and Lustig, Hanno N. and Van Nieuwerburgh, Stijn and Xiaolan, Mindy Z., Manufacturing Risk-free Government Debt (June 17, 2021). Available at SSRN: https://ssrn.com/abstract=3646430 or http://dx.doi.org/10.2139/ssrn.3646430

Zhengyang Jiang

Kellogg School of Management - Department of Finance ( email )

Evanston, IL 60208
United States

HOME PAGE: http://sites.google.com/site/jayzedwye/

Hanno N. Lustig (Contact Author)

Stanford Graduate School of Business ( email )

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National Bureau of Economic Research (NBER)

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Stijn Van Nieuwerburgh

Columbia University Graduate School of Business ( email )

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National Bureau of Economic Research (NBER)

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Centre for Economic Policy Research (CEPR)

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ABFER ( email )

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Mindy Z. Xiaolan

University of Texas, Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States

HOME PAGE: http://sites.google.com/view/mindyxiaolan

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