Should governments minimize debt service cost and risk? A closer look at the debt strategy. Simulation approach
AbstractSimulation-based cost-risk analysis of the interest expenditure is increasingly used for policy evaluation of public debt strategies by governments around the world. This paper is a first attempt to empirically evaluate this approach by comparing its implications for the maturity structure of public debt with those derived from the optimal taxation theory of debt management. To this end, we simulate the time path of the distribution of the interest expenditure for stylized portfolios of different maturities using simple stochastic models of the evolution of the term structure of interest rates, and examine the performance of such portfolios with standard cost-risk indicators. We find that: i) the ranking of debt portfolios by expenditure risk may depend on the length of the simulation period; to obtain the same policy conclusions as the optimal taxation theory, the time horizon must extend up to the redemption date of the longest maturity bond issued over the simulation period; ii) in sharp contrast with optimal taxation theory, a cost-risk trade off naturally emerges when a risk premium on long term bonds is considered, but this may not be sufficient to identify the optimal maturity structure. Our analysis points to the danger of assuming the cost-risk minimization of the interest expenditure as the main objective of debt management. A policy that either aims to minimize the interest expenditure over a too short horizon or does not consider that risk premiums may reflect a fair price for insurance may lead to sub-optimal debt strategies.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Department of Economics, Management and Quantitative Methods at Università degli Studi di Milano in its series Departmental Working Papers with number 2009-53.
Date of creation: 15 Dec 2009
Date of revision:
debt management; maturity structure; interest costs; interest rate risk; optimal taxation; simulation models; term structure;
Find related papers by JEL classification:
- E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
You can help add them by filling out this form.
CitEc Project, subscribe to its RSS feed for this item.
- Stéphane Guibaud & Yves Nosbusch & Dimitri Vayanos, 2013.
"Bond Market Clienteles, the Yield Curve, and the Optimal Maturity Structure of Government Debt,"
NBER Working Papers
18922, National Bureau of Economic Research, Inc.
- Stéphane Guibaud & Yves Nosbusch & Dimitri Vayanos, 2013. "Bond Market Clienteles, the Yield Curve, and the Optimal Maturity Structure of Government Debt," Review of Financial Studies, Society for Financial Studies, vol. 26(8), pages 1914-1961.
- Guibaud, Stéphane & Nosbusch, Yves & Vayanos, Dimitri, 2013. "Bond Market Clienteles, the Yield Curve, and the Optimal Maturity Structure of Government Debt," CEPR Discussion Papers 9407, C.E.P.R. Discussion Papers.
- Stephane Guibaud & Yves NOsbusch & Dimitri Vayanos, 2011. "Bond Market Clienteles, the Yield Curve and the Optimal Maturity Structure of Government Debt," FMG Discussion Papers dp669, Financial Markets Group.
- Holler, Johannes, 2013. "Funding Strategies of Sovereign Debt Management: A Risk Focus," Monetary Policy & the Economy, Oesterreichische Nationalbank (Austrian Central Bank), issue 2, pages 51â74.
- Alessandro Missale, 2012. "Sovereign debt management and fiscal vulnerabilities," BIS Papers chapters, in: Bank for International Settlements (ed.), Threat of fiscal dominance?, volume 65, pages 157-176 Bank for International Settlements.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (DEMM Working Papers).
If references are entirely missing, you can add them using this form.