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

17 Pages Posted: 24 Apr 2023 Last revised: 21 May 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

affiliation not provided to SSRN

Cullen Kavoussi

Federal Reserve Banks - Federal Reserve Bank of New York

Multiple version iconThere are 3 versions of this paper

Date Written: May 17, 2023

Abstract

As the debt ceiling episode unfolds, we highlight a sharp increase in trading activity and liquidity in the U.S. credit default swaps (CDS) market, as well as a spike in U.S. CDS premiums. Compared with the periods leading up to the 2011 and 2013 debt ceiling episodes, we show that elevated CDS spreads in the current environment are partially explained by the cheapening of deliverable Treasury collateral to 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 around 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 participant update 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? (May 17, 2023). FRB of Chicago Working Paper No. 2023-17, Available at SSRN: https://ssrn.com/abstract=4425863 or http://dx.doi.org/10.2139/ssrn.4425863

Luca Benzoni (Contact Author)

Federal Reserve Bank of Chicago - Research Department ( email )

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Christian Cabanilla

Federal Reserve Banks - Federal Reserve Bank of New York

Alessandro Cocco

affiliation not provided to SSRN

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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