Risk Management for Sovereign Debt Financing with Sustainability Conditions

Marialena Athanasopoulou, Andrea Consiglio (), Aitor Erce, Angel Gavilan, Edmund Moshammer and Stavros Zenios

No 367, Globalization Institute Working Papers from Federal Reserve Bank of Dallas

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.

Keywords: sovereign debts; sustainability; debt financing; optimization; stochastic programming; scenario analyses; conditional Value-at-Risk; risk measures (search for similar items in EconPapers)
JEL-codes: C61 C63 D61 E3 E47 E62 F34 G38 H63 (search for similar items in EconPapers)
Pages: 43 pages
Date: 2019-06-01
New Economics Papers: this item is included in nep-eec, nep-mac, nep-ore and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:fip:feddgw:367

DOI: 10.24149/gwp367

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