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A Critical Analysis of the Technical Assumptions of the Standard Micro Portfolio Approach to Sovereign Debt Management

  • Hans J. Blommestein
  • Anja Hubig

This paper examines the analytical underpinnings of the standard micro portfolio approach to public debt management (PDM) that aims at minimising longer-term cash-flow based borrowing costs at an acceptable level of risk. The study concludes that two technical key assumptions need to hold for the standard micro portfolio approach to yield optimal (i.e. cost-minimising) results. We argue that these assumptions do not hold in the current borrowing environment characterized by fiscal dominance with complex links between PDM and monetary policy (MP). By using the principles of portfolio theory we demonstrate that in this borrowing environment, cost-risk optimality requires the use of a broader cost concept than employed in the standard micro portfolio approach. This new concept (referred to as effective borrowing costs) incorporates not only the cash flows of the debt portfolio itself, but also those related to primary borrowing requirements. The resulting broader cost measure includes therefore the interactions with the budget. Finally, the paper demonstrates that the standard cost-risk framework of the micro portfolio approach is nested within this new, broader cost concept.

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Paper provided by OECD Publishing in its series OECD Working Papers on Sovereign Borrowing and Public Debt Management with number 4.

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Date of creation: 20 Feb 2012
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Handle: RePEc:oec:dafaaf:4-en
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  1. Albert Marcet & Elisa Faraglia & Andrew Scott, 2007. "Fiscal Insurance and Debt Management in OECD Economies," UFAE and IAE Working Papers 729.08, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
  2. Carmen M. Reinhart & Kenneth S. Rogoff, 2010. "Growth in a Time of Debt," American Economic Review, American Economic Association, vol. 100(2), pages 573-78, May.
  3. George-Marios Angeletos, 2002. "Fiscal Policy With Noncontingent Debt And The Optimal Maturity Structure," The Quarterly Journal of Economics, MIT Press, vol. 117(3), pages 1105-1131, August.
  4. Udaibir S. Das & Jay Surti & Faisal Ahmed & Michael G Papaioannou & Guilherme Pedras, 2010. "Managing Public Debt and its Financial Stability Implications," IMF Working Papers 10/280, International Monetary Fund.
  5. Faraglia, Elisa & Marcet, Albert & Scott, Andrew, 2008. "In Search of a Theory of Debt Management," CEPR Discussion Papers 6859, C.E.P.R. Discussion Papers.
  6. Emanuele Bacchiocchi & Alessandro Missale, 2005. "Managing Debt Stability," CESifo Working Paper Series 1388, CESifo Group Munich.
  7. Lustig, Hanno & Sleet, Christopher & Yeltekin, Sevin, 2008. "Fiscal hedging with nominal assets," Journal of Monetary Economics, Elsevier, vol. 55(4), pages 710-727, May.
  8. Missale, Alessandro, 1997. " Managing the Public Debt: The Optimal Taxation Approach," Journal of Economic Surveys, Wiley Blackwell, vol. 11(3), pages 235-65, September.
  9. Blommestein, Hans, 2010. "Risk Management after the Great Crash," Journal of Financial Transformation, Capco Institute, vol. 28, pages 1-19.
  10. Massimo Bernaschi & Alessandro Missale & Davide Vergni, 2009. "Should Governments Minimize Debt Service Cost and Risk?," UNIMI - Research Papers in Economics, Business, and Statistics unimi-1097, Universitá degli Studi di Milano.
  11. Robert J. Barro, 2002. "Optimal Management of Indexed and Nominal Debt," Central Banking, Analysis, and Economic Policies Book Series, in: Fernando Lefort & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Serie (ed.), Indexation, Inflation and Monetary Policy, edition 1, volume 2, chapter 5, pages 135-150 Central Bank of Chile.
  12. Hans J. Blommestein & Lex H. Hoogduin & Jolanda J.W. Peeters, 2010. "Uncertainty and risk management after the Great Moderation: The role of risk (mis)management by financial institutions," Chapters in SUERF Studies, SUERF - The European Money and Finance Forum.
  13. Yves Nosbusch, 2008. "Interest Costs and the Optimal Maturity Structure Of Government Debt," Economic Journal, Royal Economic Society, vol. 118(527), pages 477-498, 03.
  14. John Lintner, 1965. "Security Prices, Risk, And Maximal Gains From Diversification," Journal of Finance, American Finance Association, vol. 20(4), pages 587-615, December.
  15. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
  16. Henry C. Simons, 1944. "On Debt Policy," Journal of Political Economy, University of Chicago Press, vol. 52, pages 356.
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