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DEFAULT RISK PREMIA ON GOVERNMENT BONDS IN A QUANTITATIVE MACROECONOMIC MODEL

Published online by Cambridge University Press:  16 September 2014

Falko Juessen ,
Ludger Linnemann  and
Andreas Schabert
Falko Juessen
Affiliation:
Bergische Universitaet Wuppertal and IZA
Ludger Linnemann
Affiliation:
TU Dortmund University
Andreas Schabert*
Affiliation:
University of Cologne
*
Address correspondence to: Andreas Schabert, University of Cologne, Center for Macroeconomic Research, Albertus-Magnus-Platz, 50923 Cologne, Germany; e-mail: [email protected].
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Abstract

We develop a macroeconomic model in which the government does not guarantee to repay debt. We ask whether movements in the price of government bonds can be rationalized by lenders' unwillingness to fully roll over debt when the outstanding level of debt exceeds the government's repayment capacity. Investors do not support a Ponzi game in this case, but ration credit supply, thus forcing default at an endogenously determined fractional repayment rate. Interest rates on government bonds reflect expectations of this event. Numerical results show that default premia can emerge at moderately high debt-to-GDP ratios where even small changes in fundamentals lead to steeply rising interest rates. The behavior of risk premia broadly accords with recent observations for several European countries that experienced a worsening of fundamental fiscal conditions.

Keywords

Sovereign DefaultFiscal PolicyGovernment Debt
Type
Articles
Information
Macroeconomic Dynamics , Volume 20 , Issue 1 , January 2016 , pp. 380 - 403
Copyright
Copyright © Cambridge University Press 2014 

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References

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