A tale of two debt crises: a stochastic optimal control analysis
AbstractBanks should evaluate whether a borrower is likely to default. The author applies several techniques in the extensive mathematical literature of stochastic optimal control/dynamic programming to derive an optimal debt in an environment where there are risks on both the asset and liabilities sides. The vulnerability of the borrowing firm to shocks from either the return to capital, the interest rate or capital gain, increases in proportion to the difference between the Actual and Optimal debt ratio, called the excess debt. As the debt ratio exceeds the optimum, default becomes ever more likely. This paper is A Tale of Two Crises because the analysis is applied to the agricultural debt crisis of the 1980s and to the sub-prime mortgage crisis of 2007. A measure of excess debt is derived, and the author shows that it is an early warning signal of a crisis. --
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Bibliographic InfoPaper provided by Kiel Institute for the World Economy in its series Economics Discussion Papers with number 2009-44.
Date of creation: 2009
Date of revision:
Optimization; banking; stochastic optimal control; agriculture debt crisis; subprime mortgage crisis;
Other versions of this item:
- Stein, Jerome L., 2010. "A tale of two debt crises: a stochastic optimal control analysis," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy, vol. 4(3), pages 1-24.
- Jerome L. Stein, 2008. "A Tale of Two Debt Crises: A Stochastic Optimal Control Analysis," CESifo Working Paper Series 2220, CESifo Group Munich.
- C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- D91 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Consumer Choice; Life Cycle Models and Saving
- D92 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Firm Choice and Growth, Financing, Investment, and Capacity
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-10-24 (All new papers)
- NEP-RMG-2009-10-24 (Risk Management)
- NEP-URE-2009-10-24 (Urban & Real Estate Economics)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- 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.
- Wendell Fleming & Jerome L. Stein, 2002. "Stochastic Optimal Control, International Finance and Debt," CESifo Working Paper Series 744, CESifo Group Munich.
- Stein, Jerome L., 2006. "Stochastic Optimal Control, International Finance, and Debt Crises," OUP Catalogue, Oxford University Press, number 9780199280575.
- Jerome L. Stein, 2006.
"United States Current Account Deficits: A Stochastic Optimal Control Analysis,"
CESifo Working Paper Series
1805, CESifo Group Munich.
- Stein, Jerome L., 2007. "United States current account deficits: A stochastic optimal control analysis," Journal of Banking & Finance, Elsevier, vol. 31(5), pages 1321-1350, May.
- Massimo Guidolin & Elizabeth A. La Jeunesse, 2007. "The decline in the U.S. personal saving rate: is it real and is it a puzzle?," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 491-514.
- Jerome L. Stein, 2005. "Optimal Debt And Endogenous Growth In Models Of International Finance," Australian Economic Papers, Wiley Blackwell, vol. 44(4), pages 389-413, December.
- repec:fip:fedhpr:y:2008:i:may:p:171-192 is not listed on IDEAS
- Blanchet-Scalliet, Christophette & Diop, Awa & Gibson, Rajna & Talay, Denis & Tanre, Etienne, 2007. "Technical analysis compared to mathematical models based methods under parameters mis-specification," Journal of Banking & Finance, Elsevier, vol. 31(5), pages 1351-1373, May.
- Stein, Jerome L., 2011.
"The crisis, Fed, Quants and stochastic optimal control,"
Elsevier, vol. 28(1-2), pages 272-280, January.
- Stein, Jerome L., 2011. "The crisis, Fed, Quants and stochastic optimal control," Economic Modelling, Elsevier, vol. 28(1), pages 272-280.
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