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Public Debt Sustainability and Management in a Compound Option Framework

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Author Info

  • Jorge A. Chan-Lau
  • Andre Santos

Abstract

This paper introduces the Asset and Liability Management (ALM) compound option model. The model builds on the observation that the public sector net worth in a multi-period setting corresponds to the value of an option on an option on total government assets. Hence, the ALM compound option model is better suited for analyzing and evaluating the risk profile of public debt than existing one-period models, and is especially useful for analyzing the soundness of exit strategies from the large fiscal expansions undertaken by G-20 countries in the wake of the recent financial crisis. As an illustration, the model is used to analyze the risk profile and sustainability of Australia''s public debt under different policies.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 10/2.

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Length: 30
Date of creation: 01 Jan 2010
Date of revision:
Handle: RePEc:imf:imfwpa:10/2

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Related research

Keywords: Debt management; Asset management; Credit risk; Debt sustainability; Economic models; Group of Twenty; Public debt; Risk management; Asset-liablity management; default risk; Australia; probabilities; probability; public debt management; debt service; sovereign debt; debt sustainability analysis; equation; domestic debt; debt managers; equations; government debt; probability distributions; simulation results; sovereign default; correlation; external debt; debt holders; calibration; monte carlo simulations; external debts; short-term debt; debt maturity; central bank; debt burden; normal distribution; debt structure; repayment capacity; standard deviation; statistics; samples; debt service projections; foreign debt; debt restructuring; debt contracts; domestic currency; stochastic differential equation; simulation approach; currency composition; long-term debt; debt structures; normal distributions; covariance; debt-management strategy; public external debt; public sector debt; debt servicing; sensitivity analysis; private debt; random walk;

This paper has been announced in the following NEP Reports:

References

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  1. Tim Brailsford & John C. Handley & Krishnan Maheswaran, 2008. "Re-examination of the historical equity risk premium in Australia," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 48(1), pages 73-97.
  2. Andrea Gamba, 2002. "Real options Valuation: A Monte Carol Approach," Working Papers wpn02-02, Warwick Business School, Finance Group.
  3. Geske, Robert & Johnson, H. E., 1984. "The Valuation of Corporate Liabilities as Compound Options: A Correction," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 19(02), pages 231-232, June.
  4. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  5. Geske, Robert, 1977. "The Valuation of Corporate Liabilities as Compound Options," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 12(04), pages 541-552, November.
  6. Longstaff, Francis A & Schwartz, Eduardo S, 2001. "Valuing American Options by Simulation: A Simple Least-Squares Approach," University of California at Los Angeles, Anderson Graduate School of Management qt43n1k4jb, Anderson Graduate School of Management, UCLA.
  7. Cassimon, D. & Engelen, P. J. & Thomassen, L. & Van Wouwe, M., 2004. "The valuation of a NDA using a 6-fold compound option," Research Policy, Elsevier, vol. 33(1), pages 41-51, January.
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Cited by:
  1. Zaman, Constantin, 2011. "Assessing the Sustainability of Public Finances in Romania," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(2), pages 106-115, June.

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