Risk Management for Sovereign Debt Financing with Sustainability Conditions

Abstract

We develop a model of debt sustainability analysis with optimal financing decisions in the presence of macroeconomic, financial and fiscal uncertainty. We define a coherent measure of refinancing risk, and trade off the risks of debt stock and flow dynamics, subject to debt sustainability constraints and endogenous risk and term premia. We optimize both static and dynamic financing strategies, compare them with several simple rules and consol financing to demonstrate economically significant effects of optimal financing, and show that the stock-flow tradeoff can be critical for sustainability. We quantify the minimum refinancing risk and the maximum rate of debt reduction that a sovereign can achieve given its economic fundamentals, and extend the model to identify optimal timing for debt flow adjustments that allow the sovereign to go beyond these limits. We put the model to the data on three real-world cases: a representative euro zone crisis country, a low-debt country (Netherlands) and a high-debt country (Italy). These applications illustrate the use of the model in informing diverse policy decisions on sustainable public finance. The model is part of the European Stability Mechanism toolkit to assess debt sustainability and repayment capacity of member states in the context of financial assistance.

Optimal bond issuance with cost and liquidity constraints for Chinese local governments: a multi-period stochastic programming approach

“…Following previous studies (Adamo et al (2004), Hahm and Kim, (2003), Bolder (2003), Date et al (2011), Proite (2015), Eisl et al (2016), Zenios et al (2019), Ferrari (2018), Bhandari et al (2017)), we consider debt issuance strategies in terms of the cost and risk of government debt. In this paper, we aim at minimizing the expected cost of local government debt and seeking the optimal local government bond issuance strategy on the basis of controlling current and future liquidity risks and target deviation risks of debt.…”