On the Dynamic Capital Structure of Nations: Theory and Empirics

28 Pages Posted: 23 Aug 2019

See all articles by James R. Barth

James R. Barth

Auburn University; Milken Institute

YINAN NI

Auburn University

Yanfei Sun

Ryerson University

Date Written: August 20, 2019

Abstract

We analyze the optimal capital structure of a nation from a corporate finance perspective. In particular, we draw an analogy between a nation's fiat money and corporate equity following Bolton and Huang (2018). Based on dynamic capital structure theory, we develop a stochastic model to determine the optimal combination of fiat money and foreign-currency debt used by a nation to fund its investments. The optimal capital structure of a nation depends on the trade-off between the inflation risk of fiat money and the default risk of foreign-currency debt. Introducing outstanding debt to our model sheds light on how a nation dynamically adjusts its capital structure over time. Based on an analysis of 22 emerging economies, the empirical results support our theoretical model of the capital structure of a nation.

Keywords: Dynamic Capital Structure, Fiat Money, Foreign-Currency Debt, Stochastic Model, Inflation Risk, Default Risk

JEL Classification: E22, E31, E41, F34, G32

Suggested Citation

Barth, James R. and NI, YINAN and Sun, Yanfei, On the Dynamic Capital Structure of Nations: Theory and Empirics (August 20, 2019). Available at SSRN: https://ssrn.com/abstract=3440286 or http://dx.doi.org/10.2139/ssrn.3440286

James R. Barth

Auburn University ( email )

415 West Magnolia Avenue
Auburn, AL 36849
United States
334-844-2469 (Phone)
334-844-4960 (Fax)

Milken Institute ( email )

1250 Fourth Street
Santa Monica, CA 90401
United States

YINAN NI (Contact Author)

Auburn University ( email )

415 West Magnolia Avenue
Auburn, AL 36849
United States

Yanfei Sun

Ryerson University

350 Victoria Street
Toronto, Ontario M5B 2K3
Canada

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