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Stochastic Optimal Control Modeling of Debt Crises

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  • Jerome L. Stein

Abstract

What is an optimal or a sustainable external debt - for a country, region or sector? How should one monitor and evaluate debt to preclude a crisis? We use stochastic optimal control/dynamic programming to derive an optimal debt. The deviation of the actual from the optimal will serve as a Warning Signal of a crisis. There is a correspondence between Hamilton-Jacobi-Bellman equation of Dynamic Programming and the static Mean-Variance (M-V) analysis in finance. A graphic analysis of M-V is helpful to explain the implications of DP. An explicit example is the US Agricultural debt crisis.

Suggested Citation

  • Jerome L. Stein, 2003. "Stochastic Optimal Control Modeling of Debt Crises," CESifo Working Paper Series 1043, CESifo.
    • Handle: RePEc:ces:ceswps:_1043
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    1. repec:bla:ausecp:v:40:y:2001:i:4:p:417-36 is not listed on IDEAS
    2. 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.
    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. Jerome L. Stein & Giovanna Paladino, 2001. "Country Default Risk: An Empirical Assessment," Australian Economic Papers, Wiley Blackwell, vol. 40(4), pages 417-436, December.
    5. Robison, Lindon J. & Barry, Peter J. & Burghardt, William G., 1987. "Borrowing Behavior Under Financial Stress By The Proprietary Firm: A Theoretical Analysis," Western Journal of Agricultural Economics, Western Agricultural Economics Association, vol. 12(2), pages 1-8, December.
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    Cited by:

    1. Jerome L. Stein, 2009. "Application of Stochastic Optimal Control to Financial Market Debt Crises," CESifo Working Paper Series 2539, CESifo.
    2. Schleer Frauke & Semmler Willi, 2016. "Banking Overleveraging and Macro Instability: A Model and VSTAR Estimations," Journal of Economics and Statistics (Jahrbuecher fuer Nationaloekonomie und Statistik), De Gruyter, vol. 236(6), pages 609-638, December.
    3. Stein, Jerome L., 2010. "A tale of two debt crises: a stochastic optimal control analysis," Economics - The Open-Access, Open-Assessment E-Journal (2007-2020), Kiel Institute for the World Economy (IfW Kiel), vol. 4, pages 1-24.
    4. Cheng, Mei-luan & Gloy, Brent A., 2008. "The Paradox of Risk Balancing: Do Risk-reducing Policies Lead to More Risk for Farmers?," 2008 Annual Meeting, July 27-29, 2008, Orlando, Florida 6546, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
    5. 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.
    6. Adil Naamane, 2012. "Peut-on prévenir les crises financières ?," Working Papers hal-01885154, HAL.
    7. Charles I. Nkeki, 2018. "Optimal investment risks management strategies of an economy in a financial crisis," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 5(01), pages 1-24, March.

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