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Public Debt Sustainability and Management in a Compound Option Framework

  • Jorge A. Chan-Lau
  • Andre Santos

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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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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  1. 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.
  2. 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.
  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. Andrea Gamba, 2002. "Real options Valuation: A Monte Carol Approach," Working Papers wpn02-02, Warwick Business School, Finance Group.
  5. 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.
  6. 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.
  7. 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.
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