This dissertation consists of three chapters examining the interaction between government debt, taxation, and financial markets. The unifying theme across my work is the equilibrium pricing of government debt and the term structure of interest rates. In Chapter 1, I study the impact of government debt on bond yields and fiscal capacity when there is uncertainty about who will bear the burden of debt repayments. A trade-off emerges when future taxes reduce households’ exposure to income risks but expose them to unanticipated tax changes and policy uncertainty. Households’ consumption volatility, and so precautionary asset demand, scale with debt levels, but the relation is non-monotonic if there is uncertainty about relative tax incidence that is unrelated to income risks. I characterize a threshold above which further debt issuance erodes fiscal insurance and hurts welfare, and show that this threshold declines with the level of foreign demand and increases when taxation is more progressive. Negative-beta assets such as long-term debt can provide better insurance than short-term debt by lowering consumption volatility when it is needed the most. In a dynamic production economy, fiscal insurance raises interest rates, compresses risk premia, and reduces investment. I show that even in incomplete markets, a version of Ricardian neutrality holds if taxes are lump-sum. Ruling out bubbles, my results indicate that debt alone does not improve risk sharing and that supply effects will persist even if government bonds lose their specialness. In Chapter 2, I examine how the size of government debt influences the prices of both safe Treasury bonds and defaultable corporate securities. For this purpose, I study the interplay of interest rate risk, credit risk, and bond quantities in a term structure model of Treasury and corporate bond yields. The core of the theory is an endogenous connection between credit and duration risk premia through bond portfolios. Shocks to default probabilities propagate to Treasury yields through their impact on the price of interest rate risk. The dependence of credit risk premia on interest rates affects the strength of monetary policy transmission to both long term Treasury and corporate yields. Credit and duration premia amplify the effect of an increase in default rates on credit spreads. A decline in Treasury supply can adversely impact corporate yields by raising the price of credit risk through a safety channel. The impact of quantitative easing is asymmetric and depends on which assets are purchased. In Chapter 3, joint with Angelo Ranaldo and Enzo Rossi, we study how the composition of investors in the primary market impacts the borrowing costs of governments. We model a uniform-price auction for safe assets where dealers trade in both primary and secondary markets, while long-term investors hold to maturity. Uncertainty about post-auction gains leads risk-averse dealers to demand a risk premium. Dealers’ demand elasticity decreases with demand risk and heterogeneity in holding costs relative to long term investors. Inelastic demand at the auction positively predicts post-auction returns. When all bidders, including dealers and long-term investors, exhibit inelastic demand, returns remain predictable over longer horizons. Unique data on Swiss Treasury auctions with bidder identities validate the model’s empirical predictions, showing how the investor base shapes the risk–return profile of safe assets and their post-auction dynamics.
