Optimal Debt-Maturity Management (with Saki Bigio and Galo Nuño)

Abstract:
We solve the problem of a government that wants to smooth financial expenses by choosing over a continuum of bonds of different maturity. The planner takes into account that adjusting debt too fast can affect prices. At the same time, it wants to insure against several sources of risk: (a) income risk, (b) interest rate (price) risk, (c) liquidity risk (prices can become more sensitive to issuance’s), and (d) the risks in the cost of default. We characterize this infinite dimensional control problem to aid the design of the debt-maturity profile in response to these forms of risk.