Projecting the Interests of a Dynamic Debt Portfolio: a Financial Model

This paper presents a financial model developed to project the future interest expenses of a large set of rolling debt instruments. It aims at forecasting the financial consequences, for borrowing entities, of changes in the interest rate environment. Starting from detailed data on the current debt's maturity structure and interest rates, and given a future path for market interest rates, we simulate the progressive repayment of borrowed amounts refinanced by issuing new debt at prevailing conditions, with few structural assumptions. The model simulates the effect of variable-rate interests and inflation indexing. It can handle any joint future trajectory of outstanding amounts and interest rates, as represented by a full yield curve structure. We present two use cases: the French government marketable debt, and the aggregate debt of euro area non-financial corporations (NFC). In the former case, official publications of interest expenses provide a benchmark against which the model performance can be back-tested. The NFC use case provides evidence of a strong dependence of the interest expenses trajectory on debt structure, as the share of fixed-rate long-term debt varies widely across countries. The model quantifies the resulting differences in expense sensitivities to future interest rate changes.