What Does the CDS Market Imply for a U.S. Default?

28 Pages Posted: 25 Apr 2023 Last revised: 10 Oct 2023

See all articles by Luca Benzoni

Luca Benzoni

Federal Reserve Bank of Chicago - Research Department

Christian Cabanilla

Federal Reserve Banks - Federal Reserve Bank of New York

Alessandro Cocco

Federal Reserve Bank of Chicago

Cullen Kavoussi

Federal Reserve Banks - Federal Reserve Bank of New York

Multiple version iconThere are 3 versions of this paper

Date Written: September 15, 2023

Abstract

We document the sharp increase in trading activity, gross and net notional outstanding, and
overall premiums in the U.S. sovereign credit default swaps (CDS) market that took place during the 2023 debt ceiling episode. Unlike the periods leading up to the 2011 and 2013 debt ceiling
events, we show that in the recent episode elevated CDS spreads were partially due to a
high expected loss given default, because of the very low valuation of long-term Treasuries
that would have been deliverable to settle CDS contracts. We infer the likelihood of a U.S.
default from these CDS premiums and estimate an increase in the market-implied default
probability from about 0.3–0.4% in 2022, to about 4% in April 2023, which is lower than
it was in July 2011 and about where it was in October 2013. Finally, we document changes
in Treasury bills trading activity as market participants updated their expectations for a
U.S. default.

Keywords: U.S. default, U.S. CDS, default probabilities, sovereign CDS, debt ceiling

JEL Classification: G10, G12, G18, G28, E32, E43, E44

Suggested Citation

Benzoni, Luca and Cabanilla, Christian and Cocco, Alessandro and Kavoussi, Cullen, What Does the CDS Market Imply for a U.S. Default? (September 15, 2023). Available at SSRN: https://ssrn.com/abstract=4425075 or http://dx.doi.org/10.2139/ssrn.4425075

Luca Benzoni (Contact Author)

Federal Reserve Bank of Chicago - Research Department ( email )

230 South LaSalle Street
Chicago, IL 60604
United States
312-322-8499 (Phone)

HOME PAGE: http://lbenzoni.frbchi.googlepages.com/

Christian Cabanilla

Federal Reserve Banks - Federal Reserve Bank of New York

Alessandro Cocco

Federal Reserve Bank of Chicago

230 South LaSalle Street
Chicago, IL 60604
United States

Cullen Kavoussi

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

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