Sovereign Default and the Decline in Interest Rates
Max Miller, James D. Paron and Jessica A. Wachter · Review of Financial Studies, 2026 · 10.1093/rfs/hhag025
Abstract. Sovereign debt yields have undergone a historic decline over the last half century. Standard explanations, including aging populations and increases in asset demand from abroad, encounter difficulties when confronted with the full range of evidence. We propose an explanation based on a decline in inflation and default risk. We show that a model with sovereign default captures the decline in interest rates, the stability of equity valuation ratios, and the reduction in investment and output growth. Calibrations of the model post-COVID suggest that sovereign default risk may have returned.
The sovereign risk premium, updated
Sovereign debt loses value through inflation or through outright or partial default. In the paper, we provide a model for thinking about the risk premium due to this and calibrate it to data in the United States. The premium investors demand for bearing that risk is given by
p · λη · ((1 − η)−γ − 1)
where p is the chance of a disaster, η the fall in consumption when one strikes, λη the share of the bond’s value lost, and γ risk aversion. We recover λ for each period by matching the price-dividend ratio and the inflation-adjusted Treasury yield. The paper also solves a fully dynamic version of the model, but we update the simpler one here because the dynamic model’s inputs are not published as often, and in practice the two give very close answers. We also calibrate to data from the S&P 500 here instead of CRSP for the same reason.
Sovereign risk premium, annual. Every period uses the same inputs: Shiller’s price-dividend ratio, average growth in real consumption per person, as in the paper, and the one-year Treasury yield less expected inflation. Consumption growth for 2022–2026 runs through 2025. Data through September 2026.
Results are broadly similar with forecasters’ 10-year expected real GDP growth in place of consumption growth.
Replication
The package rebuilds every table, figure and number in the paper. From the unpacked folder:
uv sync
uv run scons
The README covers requirements, data sources, and the two licensed sources (WRDS and Global Financial Data) that the package cannot include.
Miller, Max, James D. Paron, and Jessica A. Wachter. “Sovereign Default and the Decline in Interest Rates.” Review of Financial Studies, published online 22 July 2026. https://doi.org/10.1093/rfs/hhag025