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http://ssrn.com/abstract=322723
 
 

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Stochastic Optimal Control, International Finance and Debt


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)

June 2002

CESifo Working Paper Series No. 744

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.

Number of Pages in PDF File: 38

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

JEL Classification: C61, D81, D9, F34

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Date posted: October 10, 2002  

Suggested Citation

Fleming, Wendell H. and Stein, Jerome L., Stochastic Optimal Control, International Finance and Debt (June 2002). CESifo Working Paper Series No. 744. Available at SSRN: http://ssrn.com/abstract=322723

Contact Information

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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