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Stochastic Optimal Control Modeling of Debt Crises

Jerome L. Stein
Brown University - Division of Applied Mathematics; CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

September 2003

CESifo Working Paper Series No. 1043

Abstract:
What is an optimal or a sustainable external debt - for a country, region or sector? How should one monitor and evaluate debt to preclude a crisis? We use stochastic optimal control/dynamic programming to derive an optimal debt. The deviation of the actual from the optimal will serve as a Warning Signal of a crisis. There is a correspondence between
Hamilton-Jacobi-Bellman equation of Dynamic Programming and the static Mean-Variance (M-V) analysis in finance. A graphic analysis of M-V is helpful to explain the implications of DP. An explicit example is the US Agricultural debt crisis.

Keywords: stochastic optimal control, debt, international finance, US agricultural crisis, Mean-Variance analysis, Hamilton-Jacobi-Bellaman equation

JEL Classifications: C61, D81, D9, F34

Working Paper Series

Date posted: November 10, 2003 ; Last revised: August 17, 2004

Suggested Citation

Stein, Jerome L., Stochastic Optimal Control Modeling of Debt Crises (September 2003). CESifo Working Paper Series No. 1043. Available at SSRN: http://ssrn.com/abstract=456161

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