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Debt Maturity: Is Long-Term Debt Optimal?

  • Laura Alfaro
  • Fabio Kanczuk

We model and calibrate the arguments in favor and against short-term and long-term debt. These arguments broadly include: maturity premium, sustainability, and service smoothing. We use a dynamic equilibrium model with tax distortions and government outlays uncertainty, and model maturity as the fraction of debt that needs to be rolled over every period. In the model, the benefits of defaulting are tempered by higher future interest rates. We then calibrate our artificial economy and solve for the optimal debt maturity for Brazil as an example of a developing country and the U.S. as an example of a mature economy. We obtain that the calibrated costs from defaulting on long-term debt more than offset costs associated with short-term debt. Therefore, short-term debt implies higher welfare levels.

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File URL: http://www.nber.org/papers/w13119.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13119.

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Date of creation: May 2007
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Publication status: published as Laura Alfaro & Fabio Kanczuk, 2009. "Debt Maturity: Is Long-Term Debt Optimal?," Review of International Economics, Blackwell Publishing, vol. 17(5), pages 890-905, November.
Handle: RePEc:nbr:nberwo:13119
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