Examination of Interest-Growth Differentials and the Risk of Sovereign Insolvency
The objective of this research was to demonstrate the (nonlinear) risks of sovereign insolvency and explore the applicability of stochastic modeling in public debt management, given a structural economic model of stochastic government debt dynamics. A stochastic optimal control model was developed t...
| Main Author: | |
|---|---|
| Format: | Article |
| Language: | English |
| Published: |
MDPI AG
2021-04-01
|
| Series: | Risks |
| Subjects: | |
| Online Access: | https://www.mdpi.com/2227-9091/9/4/75 |
| _version_ | 1797537667096772608 |
|---|---|
| author | Jussi Lindgren |
| author_facet | Jussi Lindgren |
| author_sort | Jussi Lindgren |
| collection | DOAJ |
| description | The objective of this research was to demonstrate the (nonlinear) risks of sovereign insolvency and explore the applicability of stochastic modeling in public debt management, given a structural economic model of stochastic government debt dynamics. A stochastic optimal control model was developed to model public debt dynamics based on the debt accounting identity, where the interest-growth differential obeys a continuous random process. This stochasticity represents both the interest rate risk of public debt and the variability of the growth rate of the nominal Gross Domestic Product combined. The optimal fiscal policy was analyzed in terms of the model parameters. The model was simulated, and results were visualized. The insolvency risk was demonstrated by examining the variance of the optimal process. The model was amended with hidden credit risk premia and fiscal multipliers, which forces the debt dynamics to be nonlinear in the debt ratio. The results, on the other hand, confirm that the volatility of the interest-growth differential is crucial in terms of sovereign solvency and in addition, it demonstrates the large risks stemming from the multiplier effect, which underlines the need for prudent debt management and fiscal policy. |
| first_indexed | 2024-03-10T12:19:35Z |
| format | Article |
| id | doaj.art-9c9f13ab543d4d1e819f52ccd97e82bc |
| institution | Directory Open Access Journal |
| issn | 2227-9091 |
| language | English |
| last_indexed | 2024-03-10T12:19:35Z |
| publishDate | 2021-04-01 |
| publisher | MDPI AG |
| record_format | Article |
| series | Risks |
| spelling | doaj.art-9c9f13ab543d4d1e819f52ccd97e82bc2023-11-21T15:36:23ZengMDPI AGRisks2227-90912021-04-01947510.3390/risks9040075Examination of Interest-Growth Differentials and the Risk of Sovereign InsolvencyJussi Lindgren0Department of Mathematics and Systems Analysis, Aalto University, 02150 Espoo, FinlandThe objective of this research was to demonstrate the (nonlinear) risks of sovereign insolvency and explore the applicability of stochastic modeling in public debt management, given a structural economic model of stochastic government debt dynamics. A stochastic optimal control model was developed to model public debt dynamics based on the debt accounting identity, where the interest-growth differential obeys a continuous random process. This stochasticity represents both the interest rate risk of public debt and the variability of the growth rate of the nominal Gross Domestic Product combined. The optimal fiscal policy was analyzed in terms of the model parameters. The model was simulated, and results were visualized. The insolvency risk was demonstrated by examining the variance of the optimal process. The model was amended with hidden credit risk premia and fiscal multipliers, which forces the debt dynamics to be nonlinear in the debt ratio. The results, on the other hand, confirm that the volatility of the interest-growth differential is crucial in terms of sovereign solvency and in addition, it demonstrates the large risks stemming from the multiplier effect, which underlines the need for prudent debt management and fiscal policy.https://www.mdpi.com/2227-9091/9/4/75public debtdebt dynamicsstochastic optimal controlHamilton–Jacobi–Bellman equationfiscal policynonlinear dynamics |
| spellingShingle | Jussi Lindgren Examination of Interest-Growth Differentials and the Risk of Sovereign Insolvency Risks public debt debt dynamics stochastic optimal control Hamilton–Jacobi–Bellman equation fiscal policy nonlinear dynamics |
| title | Examination of Interest-Growth Differentials and the Risk of Sovereign Insolvency |
| title_full | Examination of Interest-Growth Differentials and the Risk of Sovereign Insolvency |
| title_fullStr | Examination of Interest-Growth Differentials and the Risk of Sovereign Insolvency |
| title_full_unstemmed | Examination of Interest-Growth Differentials and the Risk of Sovereign Insolvency |
| title_short | Examination of Interest-Growth Differentials and the Risk of Sovereign Insolvency |
| title_sort | examination of interest growth differentials and the risk of sovereign insolvency |
| topic | public debt debt dynamics stochastic optimal control Hamilton–Jacobi–Bellman equation fiscal policy nonlinear dynamics |
| url | https://www.mdpi.com/2227-9091/9/4/75 |
| work_keys_str_mv | AT jussilindgren examinationofinterestgrowthdifferentialsandtheriskofsovereigninsolvency |