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Government Debt Control: Optimal Currency Portfolio and Payments

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  • Ricardo Huamán-Aguilar

    (Department of Mathematical and Statistical Sciences, University of Alberta, Edmonton, Alberta T6G 2G1, Canada)

  • Abel Cadenillas

    (Department of Mathematical and Statistical Sciences, University of Alberta, Edmonton, Alberta T6G 2G1, Canada)

Abstract

Motivated by empirical facts, we develop a theoretical model for optimal currency government debt portfolio and debt payments, which allows both government debt aversion and jumps in the exchange rates. We obtain first a realistic stochastic differential equation for public debt and then solve explicitly the optimal currency debt problem. We show that higher debt aversion and jumps in the exchange rates lead to a lower proportion of optimal debt in foreign currencies. Furthermore, we show that for a government with extreme debt aversion it is optimal not to issue debt in foreign currencies. To the best of our knowledge, this is the first theoretical model that provides a rigorous explanation of why developing countries have reduced consistently their proportion of foreign debt in their debt portfolios.

Suggested Citation

  • Ricardo Huamán-Aguilar & Abel Cadenillas, 2015. "Government Debt Control: Optimal Currency Portfolio and Payments," Operations Research, INFORMS, vol. 63(5), pages 1044-1057, October.
    • Handle: RePEc:inm:oropre:v:63:y:2015:i:5:p:1044-1057
    DOI: 10.1287/opre.2015.1412
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    References listed on IDEAS

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    1. Taylor, John B, 1979. "Estimation and Control of a Macroeconomic Model with Rational Expectations," Econometrica, Econometric Society, vol. 47(5), pages 1267-1286, September.
    2. Abel Cadenillas & Peter Lakner & Michael Pinedo, 2013. "Optimal Production Management When Demand Depends on the Business Cycle," Operations Research, INFORMS, vol. 61(4), pages 1046-1062, August.
    3. Ugo Panizza, 2008. "Domestic And External Public Debt In Developing Countries," UNCTAD Discussion Papers 188, United Nations Conference on Trade and Development.
    4. Cadenillas, Abel & Zapatero, Fernando, 1999. "Optimal Central Bank Intervention in the Foreign Exchange Market," Journal of Economic Theory, Elsevier, vol. 87(1), pages 218-242, July.
    5. Wenjing Guo & Chengming Xu, 2004. "Optimal portfolio selection when stock prices follow an jump-diffusion process," Mathematical Methods of Operations Research, Springer;Gesellschaft für Operations Research (GOR);Nederlands Genootschap voor Besliskunde (NGB), vol. 60(3), pages 485-496, December.
    6. Zapatero, Fernando, 1995. "Equilibrium asset prices and exchange rates," Journal of Economic Dynamics and Control, Elsevier, vol. 19(4), pages 787-811, May.
    7. Olivier Jean Blanchard & Stanley Fischer, 1989. "Lectures on Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262022834, April.
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    Cited by:

    1. Abel Cadenillas & Ricardo Huamán-Aguilar, 2018. "On the Failure to Reach the Optimal Government Debt Ceiling," Risks, MDPI, vol. 6(4), pages 1-28, December.
    2. Barbara Annicchiarico & Fabio Di Dio & Stefano Patrì, 2023. "Optimal correction of the public debt and measures of fiscal soundness," Metroeconomica, Wiley Blackwell, vol. 74(1), pages 138-162, February.
    3. Sandun Perera & Winston Buckley & Hongwei Long, 2018. "Market-reaction-adjusted optimal central bank intervention policy in a forex market with jumps," Annals of Operations Research, Springer, vol. 262(1), pages 213-238, March.
    4. Jussi Lindgren, 2021. "Examination of Interest-Growth Differentials and the Risk of Sovereign Insolvency," Risks, MDPI, vol. 9(4), pages 1-14, April.
    5. Ferrari, Giorgio & Rodosthenous, Neofytos, 2018. "Optimal Management of Debt-To-GDP Ratio with Regime-Switching Interest Rate," Center for Mathematical Economics Working Papers 589, Center for Mathematical Economics, Bielefeld University.
    6. Jinbiao Wu, 2019. "Optimal exchange rates management using stochastic impulse control for geometric Lévy processes," Mathematical Methods of Operations Research, Springer;Gesellschaft für Operations Research (GOR);Nederlands Genootschap voor Besliskunde (NGB), vol. 89(2), pages 257-280, April.

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