A model of safe asset determination, American Economic Review
What makes an asset a “safe asset”? We study a model where two countries each issue sovereign bonds to satisfy investors’ safe asset demands. The countries differ in the float of their bonds and the fundamental resources available to rollover debts. A sovereign’s debt is safer if its fundamentals are strong relative to other possible safe assets, not merely strong on an absolute basis. If demand for safe assets is high, a large float enhances safety through a market depth benefit. If demand for safe assets is low, then large debt size is a negative as rollover risk looms large.
Konstantin Milbradt, Arvind Krishnamurthy, Zhiguo He
Milbradt, Konstantin, Arvind Krishnamurthy, and Zhiguo He. 2019. A model of safe asset determination. American Economic Review. 109(4)