Risk Management for Sovereign Debt Financing with Sustainability Conditions

49 Pages Posted: 17 Sep 2018 Last revised: 29 Aug 2019

See all articles by Stavros A. Zenios

Stavros A. Zenios

University of Cyprus; Bruegel; University of Pennsylvania - Wharton Financial Institutions Center

Andrea Consiglio

University of Palermo - d/SEAS

Marialena Athanasopoulou

European Stability Mechanism

Edmund Moshammer

European Stability Mechanism

Angel Gavilan Gonzalez

European Stability Mechanism

Aitor Erce

European Union - European Investment Bank; European University Institute

Multiple version iconThere are 2 versions of this paper

Date Written: June 1, 2019

Abstract

We develop a model of debt sustainability analysis with optimal financing decisions in the presence of macroeconomic, financial, and fiscal uncertainty. We define a coherent measure of refinancing risk, and trade-off the risks of the debt stock and flow dynamics, subject to debt sustainability constraints and endogenous risk and term premia. We optimize both static and dynamic financing strategies, compare them with several simple rules and consol financing to demonstrate economically significant effects of optimal financing, and show that the stock-flow tradeoff can be critical for sustainability. We quantify the minimum refinancing risk and the maximum rate of debt reduction that a sovereign can achieve given its economic fundamentals and extend the model to identify the optimal timing for debt flow adjustments that allow the sovereign to go beyond these limits. We put the model to the data on three real-world cases: a representative eurozone crisis country, a low-debt country (Netherlands), and a high-debt country (Italy). These applications illustrate the use of the model in informing diverse policy decisions on sustainable public finance. The model is part of the European Stability Mechanism toolkit to assess debt sustainability and repayment capacity of member states in the context of financial assistance.

Keywords: sovereign debt, sustainability, debt financing, optimization, stochastic programming, scenario analysis, conditional value-at-risk, risk measures

JEL Classification: C61, C63, D61,E3, E47, E62, F34, G38, H63

Suggested Citation

Zenios, Stavros A. and Consiglio, Andrea and Athanasopoulou, Marialena and Moshammer, Edmund and Gavilan Gonzalez, Angel and Erce, Aitor, Risk Management for Sovereign Debt Financing with Sustainability Conditions (June 1, 2019). Federal Reserve Bank of Dallas Globalization Institute Working Paper 367, and European Stability Mechanism Working Paper 31 (Revised). Available at SSRN: https://ssrn.com/abstract=3250806 or http://dx.doi.org/10.2139/ssrn.3250806

Stavros A. Zenios (Contact Author)

University of Cyprus ( email )

75 Kallipoleos Street
P.O. Box 20537
Nicosia CY-1678
Cyprus
+357 2 893605 (Phone)

HOME PAGE: http://https://www.researchgate.net/profile/Stavros_Zenios

Bruegel ( email )

Rue de la Charité 33
B-1210 Brussels Belgium, 1210
Belgium

University of Pennsylvania - Wharton Financial Institutions Center ( email )

3733 Spruce Street
Philadelphia, PA 19104-6374
United States

HOME PAGE: http://zenios.wordpress.com

Andrea Consiglio

University of Palermo - d/SEAS ( email )

Viale delle Scienze, edificio 13
Palermo, 90124
Italy

HOME PAGE: http://portale.unipa.it/persone/docenti/c/andrea.consiglio

Marialena Athanasopoulou

European Stability Mechanism ( email )

6a Circuit de la Foire Internationale
L-1347
Luxembourg

Edmund Moshammer

European Stability Mechanism ( email )

6a Circuit de la Foire Internationale
L-1347
Luxembourg

Angel Gavilan Gonzalez

European Stability Mechanism ( email )

6a Circuit de la Foire Internationale
L-1347
Luxembourg

Aitor Erce

European Union - European Investment Bank ( email )

98-100 Boulevard Konrad Adenauer
L-2950
Luxembourg

European University Institute ( email )

Villa Schifanoia
133 via Bocaccio
Firenze (Florence), Tuscany 50014
Italy

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