Examination of interest-growth differentials and the risk of sovereign insolvency
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A1 Alkuperäisartikkeli tieteellisessä aikakauslehdessä
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Date
2021-04
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Language
en
Pages
14
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Risks, Volume 9, issue 4
Abstract
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 param-eters. 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.Description
Publisher Copyright: © 2021 by the authors. Licensee MDPI, Basel, Switzerland. Copyright: Copyright 2021 Elsevier B.V., All rights reserved.
Keywords
Debt dynamics, Fiscal policy, Hamilton–Jacobi–Bellman equa-tion, Nonlinear dynamics, Public debt, Stochastic optimal control
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Citation
Lindgren, J 2021, ' Examination of interest-growth differentials and the risk of sovereign insolvency ', Risks, vol. 9, no. 4, 75 . https://doi.org/10.3390/risks9040075