Debt Maturity: Is Long-Term Debt Optimal?

16 Pages Posted: 2 Nov 2009

See all articles by Laura Alfaro

Laura Alfaro

Harvard University

Fabio Kanczuk

University of São Paulo (USP) - Department of Economics

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Abstract

We model and calibrate the arguments in favor and against short-term and long-term debt. These arguments broadly include: maturity premium, sustainability, and service smoothing. We use a dynamic-equilibrium model with tax distortions and government outlays uncertainty, and model maturity as the fraction of debt that needs to be rolled over every period. In the model, the benefits of defaulting are tempered by higher future interest rates. We then calibrate our artificial economy and solve for the optimal debt maturity for Brazil as an example of a developing country and the US as an example of a mature economy. We obtain that the calibrated costs from defaulting on long-term debt more than offset costs associated with short-term debt. Therefore, short-term debt implies higher welfare levels.

Suggested Citation

Alfaro, Laura and Kanczuk, Fabio, Debt Maturity: Is Long-Term Debt Optimal?. Review of International Economics, Vol. 17, Issue 5, pp. 890-905, November 2009, Available at SSRN: https://ssrn.com/abstract=1495969 or http://dx.doi.org/10.1111/j.1467-9396.2009.00851.x

Laura Alfaro

Harvard University ( email )

Cambridge, MA 02138
United States

Fabio Kanczuk

University of São Paulo (USP) - Department of Economics ( email )

Av. Prof. Luciano Gualberto 908
Sao Paulo SP, 05508-900
Brazil
011-55-11-818-5915 (Phone)
011-55-11-3661-7333 (Fax)

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