Should governments minimize debt service cost and risk? A closer look at the debt strategy. Simulation approach
Simulation-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.
|Date of creation:||15 Dec 2009|
|Contact details of provider:|| Postal: Via Conservatorio 7, I-20122 Milan - Italy|
Phone: +39 02 50321522
Fax: +39 02 50321505
Web page: http://www.demm.unimi.it
More information through EDIRC
When requesting a correction, please mention this item's handle: RePEc:mil:wpdepa:2009-53. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (DEMM Working Papers)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.