Stochastic Optimal Control, International Finance and Debt
AbstractWe use stochastic optimal control-dynamic programming (DP) to derive the optimal foreign debt/net worth, consumption/net worth, current account/net worth, and endogenous growth rate in an open economy. Unlike the literature that uses an Intertemporal Budget Constraint (IBC) or the Maximum Principle, the DP approach does not require perfect foresight or certainty equivalence. Errors of measurement and the effects of unanticipated shocks are corrected in an optimal manner. We contrast the DP and IBC approaches, show how the results of the dynamic programming approach can be interpreted in a traditional simple mean-variance/Tobin-Markowitz context, and explain why our results are generalizations of the Merton model.
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Bibliographic InfoPaper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 744.
Date of creation: 2002
Date of revision:
stochastic optimal control; foreign debt; international finance; vulnerability to external shocks; sustainable current account deficits;
Other versions of this item:
- Fleming, Wendell H. & Stein, Jerome L., 2004. "Stochastic optimal control, international finance and debt," Journal of Banking & Finance, Elsevier, vol. 28(5), pages 979-996, May.
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