A Framework For Debt Maturity Management

We characterize the optimal debt-maturity management problem of a government in a small open economy. The government issues a continuum of finite-maturity bonds in the presence of liquidity frictions. We find that the solution can be decentralized: the optimal issuance of a bond of a given maturity is proportional to the difference between its market price and its domestic valuation, the latter defined as the price computed using the government’s discount factor. We show how the steady-state debt distribution decreases with maturity. These results hold when extending the model to incorporate aggregate risk or strategic default.

We characterize the long-run stable maturity distribution induced by a fixed issuance policy, defined as the maturity mix of new issues, thereby providing a method to link issuance policies with their long-run consequences. We derive closed-form expressions for a new class of forward-looking stable metrics, including per-period refinancing need, debt service cost, and average maturity -- an indicator of the supply of long-term bonds. We use these metrics to provide a normative analysis of the classical debt-management tradeoff between refinancing risk and debt service cost. Our results indicate that the US Treasury could move closer to the “efficient frontier” by tilting its issuance towards notes.

We characterize the optimal debt-maturity management problem in the presence of liquidity costs. A government issues an arbitrary number of finite-maturity bonds and faces income and interest-rate risk, which can tempt it to default. Optimal issuances are spread out across maturities and are given by the ratio of a value gap over a liquidity coefficient that measures the price impact. The value gap is the proportional difference between the bond prices obtained by discounting with the international interest rates and with the domestic discount factor. This characterization allows us to quantify the contribution of different economic forces--impatience, yield-curve riding, expenditure smoothing, self-insurance, credit risk, and default incentives--in shaping the optimal debt maturity distribution. In an application, we estimate the liquidity coefficients using Spanish debt auction data and exploit the framework to evaluate Spanish debt management practices.

As Europe proceeds towards economic and monetary union, fiscal convergence and the prospect of a common money are at the centre of discussion. This volume from the Centre for Economic Policy Research brings together theoretical, applied and historical research on the management of public debt and its implications for financial stability. Gale fills a gap in the literature, using a consistent framework to investigate the welfare economics of public debt, while Calvo and Guidotti analyse the trade-off between indexation and maturity when it comes to minimizing debt service. Confidence crises have become relevant again in view of the high debt ratios in countries such as Belgium, Italy and Ireland. Alesina, Prati and Tabellini develop a formal model of the propagation of a debt run and use it to interpret Italian debt panics. Giavazzi and Pagano concentrate on how inappropriate debt management can precipitate a run on the currency while Makinen and Woodward review a broad sweep of historical experience.

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This report provides guidance on using the Analytical Tool of the Medium-Term Debt Management Strategy (MTDS). The MTDS framework consists of a methodology, published as the ‘Guidance Note for Developing a Medium-Term Debt Management Strategy’, and an associated analytical tool (AT) that can be used to assess the cost-risk trade-offs of alternative strategies to help identify the preferred strategy. The MTDS framework supported by the AT quantitative analysis helps to determine the financing strategy. The chosen debt management strategy sets out the financing composition path to meet the debt management objective(s). The profile of future interest payments and the amortizations of new debt are driven by the debt management strategy. The MTDS AT is based on annual cash flow. Although this assumption is enough for analyzing alternative debt management strategies, in some cases, particularly for countries that are heavily dependent on short-term securities with maturities of less than a year, it would be helpful to work with cash flows with higher frequency.

This paper examines ways to summarize the maturity structure of public debts using a small number of parameters. We compile a novel dataset of all promised future payments for US and UK government debt from every month since 1869, and more recently for Peru, Poland, Egypt, and Nigeria. We show that there is a unique parametric form which does not arbitrarily restrict debt issuance – portfolios of bonds with exponential coupons. Compared to the most popular alternative, this form 1) more accurately describes changes in debt maturity for these six countries and 2) gives a quite different interpretation of historical debt maturity. Our work can be applied not just to analyze past debt movements, but – because parameter estimates are relatively similar across countries – also for monitoring changes in debt maturity, including in countries where data are partial or incomplete.

Understanding the dynamic evolution of the yield curve is critical to many financial tasks, including pricing financial assets and their derivatives, managing financial risk, allocating portfolios, structuring fiscal debt, conducting monetary policy, and valuing capital goods. Unfortunately, most yield curve models tend to be theoretically rigorous but empirically disappointing, or empirically successful but theoretically lacking. In this book, Francis Diebold and Glenn Rudebusch propose two extensions of the classic yield curve model of Nelson and Siegel that are both theoretically rigorous and empirically successful. The first extension is the dynamic Nelson-Siegel model (DNS), while the second takes this dynamic version and makes it arbitrage-free (AFNS). Diebold and Rudebusch show how these two models are just slightly different implementations of a single unified approach to dynamic yield curve modeling and forecasting. They emphasize both descriptive and efficient-markets aspects, they pay special attention to the links between the yield curve and macroeconomic fundamentals, and they show why DNS and AFNS are likely to remain of lasting appeal even as alternative arbitrage-free models are developed. Based on the Econometric and Tinbergen Institutes Lectures, Yield Curve Modeling and Forecasting contains essential tools with enhanced utility for academics, central banks, governments, and industry.