Risk Management for Sustainable Sovereign Debt Financing

44 Pages Posted: 17 Sep 2018 Last revised: 30 Mar 2021

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

UPNA

Multiple version iconThere are 2 versions of this paper

Date Written: June 1, 2019

Abstract

We model sovereign debt sustainability with optimal financing decisions under macroeconomic, financial, and fiscal uncertainty, with endogenous risk and term premia. Using a coherent risk measure we trade off debt stock and flow risks subject to sustainability constraints. We optimize static and dynamic financing strategies, and demonstrate economically significant savings from optimal financing compared to simple rules and consol financing, and find that optimizing the tradeoffs can be critical for sustainability. The model quantifies minimum refinancing risk and maximum rate of debt reduction that a sovereign can achieve given its economic fundamentals, and an extension identifies optimal timing of flow adjustments that allow the sovereign to go beyond these limits. We put the model to the data on a eurozone crisis country, a low-debt (Netherlands), and a high-debt (Italy) country, and document the significance of the stock-flow tradeoff for debt sustainability, identify potential improvements of the Dutch Treasury practices, and non-sustainability risks in the 2019 Italian budget. The model informs diverse policy decisions on sustainable public finance, and is an essential building block of the European Stability Mechanism methodological framework to assess debt sustainability and repayment capacity of member states, especially 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 Sustainable Sovereign Debt Financing (June 1, 2019). Operations Research, published on line 18 Jan. 2021. , 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

UPNA ( email )

Pamplona
Spain

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