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Survival Maximizing Leverage of an Economy: The Case of Greece

Listed author(s):
  • Haluk Yener

    ()

    (Department of Business Administration, Istanbul Bilgi University, Turkey)

  • Thanasis Stengos

    ()

    (Department of Economics, University of Guelph, Canada; The Rimini Centre for Economic Analysis, Italy)

  • M. Ege Yazgan

    ()

    (Department of Economics, Kadir Has University, Turkey; The Rimini Centre for Economic Analysis, Italy)

In this paper, we solve two problems related to growth and survival probability maximization of an economy. We assume that the problems are subject to the stochastic net worth model introduced by Fleming and Stein (2004) and apply the techniques of stochastic optimal control theory in order to find our results. Via the results, we first establish the analytical specifications for the minimum goal reaching and maximum survival times of an economy. Given these, we show that the growth maximizing strategy enhances both the survival and goal reaching times besides its growth enhancing property. We also provide a closed form solution for the estimated debt crisis time of a non-resilient economy. Furthermore, by considering a fixed proportional consumption rate, we specify survival probability maximizing leverage as a function of this rate and show how optimal leverage strategy changes as the conditions of the economy changes. Mainly, we show that under bad economic conditions, bold leverage strategy must be followed at the expense of growth for the survival probability maximization. On the other hand, under good economic conditions, timid strategies are better as excessive risk taking must be avoided for the survival probability maximization. Again, for the same objective, we show that as an economy becomes less self sufficient, then, it needs to resort to external funds in order to finance its consumption, which may in turn lead excessive borrowing that may end up with debt crisis as it did in Greece.

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Paper provided by The Rimini Centre for Economic Analysis in its series Working Paper Series with number 15-17.

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Date of creation: Apr 2015
Handle: RePEc:rim:rimwps:15-17
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  1. Elmendorf, Douglas W. & Gregory Mankiw, N., 1999. "Government debt," Handbook of Macroeconomics,in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 25, pages 1615-1669 Elsevier.
  2. Jerome L. Stein, 2005. "Optimal Debt And Endogenous Growth In Models Of International Finance," Australian Economic Papers, Wiley Blackwell, vol. 44(4), pages 389-413, December.
  3. Stein, Jerome L & Paladino, Giovanna, 2001. "Country Default Risk: An Empirical Assessment," Australian Economic Papers, Wiley Blackwell, vol. 40(4), pages 417-436, December.
  4. Stein, Jerome L., 2006. "Stochastic Optimal Control, International Finance, and Debt Crises," OUP Catalogue, Oxford University Press, number 9780199280575.
  5. Stein, Jerome L & Paladino, Giovanna, 2001. "Country Default Risk: An Empirical Assessment," Australian Economic Papers, Wiley Blackwell, vol. 40(4), pages 417-436, December.
  6. Carmen M. Reinhart & Kenneth S. Rogoff, 2010. "Growth in a Time of Debt," American Economic Review, American Economic Association, vol. 100(2), pages 573-578, May.
  7. Stein, Jerome L., 2007. "United States current account deficits: A stochastic optimal control analysis," Journal of Banking & Finance, Elsevier, vol. 31(5), pages 1321-1350, May.
  8. Kourtellos, Andros & Stengos, Thanasis & Tan, Chih Ming, 2013. "The effect of public debt on growth in multiple regimes," Journal of Macroeconomics, Elsevier, vol. 38(PA), pages 35-43.
  9. Merton, Robert C., 1971. "Optimum consumption and portfolio rules in a continuous-time model," Journal of Economic Theory, Elsevier, vol. 3(4), pages 373-413, December.
  10. Fleming, Wendell H. & Stein, Jerome L., 2004. "Stochastic optimal control, international finance and debt," Journal of Banking & Finance, Elsevier, vol. 28(5), pages 979-996, May.
  11. Jerome L. Stein, 2011. "The Diversity of Debt Crises in Europe," CESifo Forum, Ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 12(4), pages 44-51, December.
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