The Nature of the Risk-Free Asset : Evidence from Credit Default Swaps

US sovereign debt is widely regarded as risk-free on nominal terms. However, between January 2008 and September 2010, US sovereign credit default swaps (CDS) traded at premium to a sample of US corporate CDSs. The implied default probabilities from CDS premiums show that the US government is more likely to default than these firms. We find no evidence that changes in fundamental default risk are responsible for this premium difference. Traditional explanations such as differences in recovery rates, counterparty risk and cheapest-to-deliver options also cannot explain it. Changes in comovement “factors” that represent spillover effects from the default risk of European countries, and liquidity, appear to drive the observed premium difference