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Sustaining a Time-Consistent Ramsey Plan with Options

Listed author(s):
  • Francois Velde
  • Thomas Sargent

Where the state evolves according to a discrete-state Markov chain, we sustain Lucas and Stokey's debt structure dynamics by having it emerge sequentially as the unique outcome of a sequence of choices made by two sequences of independent government departments. Each period a tax authority sets taxes, taking the debt structure as given. Each period, a debt management authority exercises a financial option that it has inherited, then structures another financial option to hand down to the successor debt management authority. We exhibit equilibrium continuation government coupons in this Markov setting and how they can be interpreted as implementing a particular European call option. We interpret these European calls as a simple instance of the `five-twenties' (callable after five years, redeemable after twenty) that the U.S. used to finance itself during the War of Rebellion

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Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 607.

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Date of creation: 2004
Handle: RePEc:red:sed004:607
Contact details of provider: Postal:
Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

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