Returns to Public Debt: The US Federal Budget Deficit and the Cross Section of Equity Returns
46 Pages Posted: 18 Feb 2015
Date Written: November 12, 2014
This paper investigates the implications of changes in the US federal budget deficit for asset pricing. A portfolio-based risk factor related to changes in the budget deficit is formulated and its cross-sectional properties are analyzed. The average spread between equities exhibiting the highest negative cumulative impulse responses to shocks in the budget deficit and equities exhibiting the least sensitivity is found to be significantly negative. Traditional asset pricing cannot explain this pattern. The spread appears to be highly correlated with the business cycle and generates high payoffs when the economy is in a poor state.
Keywords: Asset pricing, US federal budget deficit, Equity returns, Macroeconomic risk
JEL Classification: G12, G14
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