Risk Management Optimization for Sovereign Debt Restructuring
Journal of Globalization and Development, Vol. 6(2), pp. 181–213, Feb. 2016.
28 Pages Posted: 11 Aug 2014 Last revised: 22 May 2016
Date Written: December 1, 2015
Debt restructuring is one of the policy tools available for resolving sovereign debt crises and, while unorthodox, it is not uncommon. We propose a scenario analysis for debt sustainability and integrate it with scenario optimization for risk management in restructuring sovereign debt. The scenario dynamics of debt-to-GDP ratio are used to define a tail risk measure, termed "conditional Debt-at-Risk". A multi-period stochastic programming model minimizes the expected cost of debt financing subject to risk limits. It provides an operational model to handle significant aspects of debt restructuring: it collects all debt issues in a common framework, and can include contingent claims, multiple currencies and step-up or linked contractual features. Alternative debt profiles -- obtained by maturity rescheduling, interest payment concessions or nominal value haircuts -- are analyzed for their expected cost-risk tradeoffs. With a suitable re-calculation of the efficient frontier, the risk of debt unsustainability of alternative risk profiles can be ascertained with a given confidence level. The model is applied to Greece sovereign debt crisis analyzing the suitability of various proposals to restore debt sustainability.
Keywords: sovereign debt, restructuring, scenario optimization, stochastic programming, Value-at-Risk, conditional Value-at-Risk, Greek crisis
JEL Classification: C61, C63, D61,E3, E47, E62, F34, G38, H63
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