Stochastic Optimal Control, International Finance and Debt

38 Pages Posted: 10 Oct 2002

See all articles by Wendell H. Fleming

Wendell H. Fleming

Brown University - Division of Applied Mathematics

Jerome L. Stein

Brown University - Division of Applied Mathematics; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: June 2002

Abstract

We use stochastic optimal control-dynamic programming (DP) to derive the optimal foreign debt/net worth, consumption/net worth, current account/net worth, and endogenous growth rate in an open economy. Unlike the literature that uses an Intertemporal Budget Constraint (IBC) or the Maximum Principle, the DP approach does not require perfect foresight or certainty equivalence. Errors of measurement and the effects of unanticipated shocks are corrected in an optimal manner. We contrast the DP and IBC approaches, show how the results of the dynamic programming approach can be interpreted in a traditional simple mean-variance/Tobin-Markowitz context, and explain why our results are generalizations of the Merton model.

Keywords: Stochastic Optimal Control, Foreign Debt, International Finance, Vulnerability to External Shocks, Sustainable Current Account Deficits

JEL Classification: C61, D81, D9, F34

Suggested Citation

Fleming, Wendell and Stein, Jerome L., Stochastic Optimal Control, International Finance and Debt (June 2002). Available at SSRN: https://ssrn.com/abstract=322723 or http://dx.doi.org/10.2139/ssrn.322723

Wendell Fleming

Brown University - Division of Applied Mathematics ( email )

Providence, RI 02912
United States

Jerome L. Stein (Contact Author)

Brown University - Division of Applied Mathematics ( email )

Providence, RI 02912
United States
401-863-2143 (Phone)
401-863-1355 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

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