Nina Boyarchenko and Or Shachar

How should we measure market expectations of the U.S. government failing to meet its debt obligations and thereby defaulting? A natural candidate would be to use the spreads on U.S. sovereign single-name credit default swaps (CDS): since a CDS provides insurance to the buyer for the possibility of default, an increase in the CDS spread would indicate an increase in the market-perceived probability of a credit event occurring. In this post, we argue that aggregate measures of activity in U.S. sovereign CDS mask a decrease in risk-forming transactions after 2014. That is, quoted CDS spreads in this market are based on few, if any, market transactions and thus may be a misleading indicator of market expectations.