Essays on Maturity Structure of Sovereign Debt

Abstract

In the first chapter, I develop a tractable model to study the optimal debt maturity

structure and fiscal policy in an environment with incomplete markets, lack of commitment,

and opportunity to default by the government. The default on public debt

is endogenous and the real interest rate reflects the default risk and the marginal rate

of substitution between present and future consumption. I show that the maturity is

used to resolve the time-consistency problem: The present government can incentivize

future governments to stick to an ex ante optimal sequence of fiscal policies and

interest rates.

In the second chapter, I show that if both risk-free interest rates and risk premiums

can be manipulated, the optimal maturity structure tends to have a decaying profile:

The government issues debt at all maturity dates, but the distribution of payments

over time is skewed toward the short-term end. Debt maturity data across countries

are consistent with model predictions.

In the last chapter, I study the sovereign debt maturity structure of a small-open

economy in a model with stochastic interest rates and opportunity to default by the

government. If default premiums are perfectly foreseen, the optimal debt policy is to

issue only one-period debt. Short-term debt disciplines the future governments not to

over borrow compared to ex ante optimal allocations because, otherwise, the sovereign

has an incentive to dilute the value of long-term debt ex post. If default premiums are

stochastic but locally independent of level of debt, sovereign issues consol bonds or

maturity is flat. Flat maturity hedges the government against unpredictable swings in

interest rates and smooths consumption over states of the world. If default premiums

are stochastic (so that maturity can be used as a hedging against changes in interest

rates) and continuously increasing in outstanding debt (so that sovereign has an

incentive to use short-term debt to minimize dilution of long-term debt in the future),

the optimal maturity is mostly short-term debt as minimizing costs associated with

lack of commitment is quantitatively more important compared to minimizing costs

associated with lack of insurance.