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Federal Reserve Bank of Dallas
Globalization Institute Working Papers
Risk Management for Sovereign Debt Financing with Sustainability Conditions
Stavros A. Zenios
Andrea Consiglio
Marialena Athanasopoulou
Edmund Moshammer
Angel Gavilan
Aitor Erce
Abstract

We develop a model of debt sustainability analysis with optimal financing decisions in the presence of macroeconomic, financial and fiscal uncertainty. We define a coherent measure of refinancing risk, and trade off the risks of debt stock and flow dynamics, subject to debt sustainability constraints and endogenous risk and term premia. We optimize both static and dynamic financing strategies, compare them with several simple rules and consol financing to demonstrate economically significant effects of optimal financing, and show that the stock-flow tradeoff can be critical for sustainability. We quantify the minimum refinancing risk and the maximum rate of debt reduction that a sovereign can achieve given its economic fundamentals, and extend the model to identify optimal timing for debt flow adjustments that allow the sovereign to go beyond these limits. We put the model to the data on three real-world cases: a representative euro zone crisis country, a low-debt country (Netherlands) and a high-debt country (Italy). These applications illustrate the use of the model in informing diverse policy decisions on sustainable public finance. The model is part of the European Stability Mechanism toolkit to assess debt sustainability and repayment capacity of member states in the context of financial assistance.


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Stavros A. Zenios & Andrea Consiglio & Marialena Athanasopoulou & Edmund Moshammer & Angel Gavilan & Aitor Erce, Risk Management for Sovereign Debt Financing with Sustainability Conditions, Federal Reserve Bank of Dallas, Globalization Institute Working Papers 367, 01 Jun 2019.
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Keywords: sovereign debt; sustainability; debt financing; optimization; stochastic programming; scenario analysis; conditional Value-at-Risk; risk measures
DOI: 10.24149/gwp367
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