Benchmark Interest Rates When the Government is Risky / Patrick Augustin, Mikhail Chernov, Lukas Schmid, Dongho Song.

Format:

Book

Author/Creator:

Augustin, Patrick.

Contributor:

National Bureau of Economic Research.

Chernov, Mikhail.

Schmid, Lukas.

Song, Dongho.

Series:

Working Paper Series (National Bureau of Economic Research) no. w26429.

NBER working paper series no. w26429

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2019.

Summary:

Since the Global Financial Crisis, rates on interest rate swaps have fallen below maturity matched U.S. Treasury rates across different maturities. Swap rates represent future uncollateralized borrowing between banks. Treasuries should be expensive and produce yields that are lower than those of maturity matched swap rates, as they are deemed to have superior liquidity and to be safe, so this is a surprising development. We show, by no-arbitrage, that the U.S. sovereign default risk explains the negative swap spreads over Treasuries. This view is supported by a quantitative equilibrium model that jointly accounts for macroeconomic fundamentals and the term structures of interest and U.S. credit default swap rates. We account for interbank credit risk, liquidity effects, and cost of collateralization in the model. Thus, the sovereign risk explanation complements others based on frictions such as balance sheet constraints, convenience yield, and hedging demand.

Notes:

Print version record

November 2019.