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In Search of a Theory of Debt Management

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dc.creator Faraglia, Elisa
dc.creator Marcet, Albert
dc.creator Scott, Andrew
dc.date 2008-05-27T07:45:25Z
dc.date 2008-05-27T07:45:25Z
dc.date 2008-05-07
dc.date.accessioned 2017-01-31T01:27:47Z
dc.date.available 2017-01-31T01:27:47Z
dc.identifier http://hdl.handle.net/10261/4539
dc.identifier.uri http://dspace.mediu.edu.my:8181/xmlui/handle/10261/4539
dc.description Trabajo publicado como artículo en Journal of Monetary Economics 57(7): 821-836 (2010).-- http://dx.doi.org/10.1016/j.jmoneco.2010.08.005
dc.description A growing literature integrates theories of debt management into models of optimal fiscal policy. One promising theory argues that the composition of government debt should be chosen so that fluctuations in the market value of debt offset changes in expected future deficits. This complete market approach to debt management is valid even when the government only issues non-contingent bonds. A number of authors conclude from this approach that governments should issue long term debt and invest in short term assets.
dc.description We argue that the conclusions of this approach are too fragile to serve as a basis for policy recommendations. This is because bonds at different maturities have highly correlated returns, causing the determination of the optimal portfolio to be ill-conditioned. To make this point concrete we examine the implications of this approach to debt management in various models, both analytically and using numerical methods calibrated to the US economy. We find the complete market approach recommends asset positions which are huge multiples of GDP. Introducing persistent shocks or capital accumulation only worsens this problem. Increasing the volatility of interest rates through habits partly reduces the size of these simulations we find no presumption that governments should issue long term debt-policy recommendations can be easily reversed through small perturbations in the specification of shocks or small variations in the maturity of bonds issued.
dc.description We further extend the literature by removing the assumption that governments every period costlessly repurchase all outstanding debt. This exacerbates the size of the required positions, worsens their volatility and in some cases produces instability in debt holdings.
dc.description We conclude that it is very difficult to insulate fiscal policy from shocks by using the complete markets approach to debt management. Given the limited variability of the yield curve using maturities is a poor way to substitute for state contingent debt. The result is the positions recommended by this approach conflict with a number of features that we believe are important in making bond markets incomplete e.g allowing for transaction costs, liquidity effects, etc.. Until these features are all fully incorporated we remain in search of a theory of debt management capable of providing robust policy insights.
dc.description Marcet's contribution was funded in part by CREI, DGES, CREA program of "Barcelona Economics" and CIRIT. Faraglia and Scott gratefully acknowledge funding from the ESRC's World Economy and Finance program.
dc.format 387158 bytes
dc.format application/pdf
dc.language eng
dc.relation UFAE and IAE Working Papers
dc.relation 743.08
dc.rights openAccess
dc.subject Complete Markets
dc.subject Debt Management
dc.subject Government Debt
dc.subject Maturity Structure
dc.subject Yield Curve
dc.title In Search of a Theory of Debt Management
dc.type Documento de trabajo

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