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Stochastic Optimal Control Modeling of Debt Crises

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  • Jerome L. Stein

Abstract

What is an optimal or a sustainable external debt - for a country, region or sector? How should one monitor and evaluate debt to preclude a crisis? We use stochastic optimal control/dynamic programming to derive an optimal debt. The deviation of the actual from the optimal will serve as a Warning Signal of a crisis. There is a correspondence between Hamilton-Jacobi-Bellman equation of Dynamic Programming and the static Mean-Variance (M-V) analysis in finance. A graphic analysis of M-V is helpful to explain the implications of DP. An explicit example is the US Agricultural debt crisis.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 1043.

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Date of creation: 2003
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Handle: RePEc:ces:ceswps:_1043

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Keywords: stochastic optimal control; debt; international finance; US agricultural crisis; Mean-Variance analysis; Hamilton-Jacobi-Bellaman equation;

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  1. Stein, Jerome L & Paladino, Giovanna, 2001. "Country Default Risk: An Empirical Assessment," Australian Economic Papers, Wiley Blackwell, vol. 40(4), pages 417-36, December.
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