The price of a safe asset reflects not only the expected discounted future cash
flows but also future service flows, since retrading allows partial insurance of id iosyncratic risk in an incomplete markets setting. This lowers the issuers’ interest
burden. As idiosyncratic risk rises during recessions, so does the value of the ser ...
The price of a safe asset reflects not only the expected discounted future cash
flows but also future service flows, since retrading allows partial insurance of id iosyncratic risk in an incomplete markets setting. This lowers the issuers’ interest
burden. As idiosyncratic risk rises during recessions, so does the value of the ser vice flows bestowing the safe asset with a negative β. The resulting exorbitant
privilege resolves government debt valuation puzzles and allows the government
to run a permanent (primary) deficit without ever paying back its debt, but the
government faces a “Debt Laffer Curve”.