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Stochastic Optimal Control, International Finance, and Debt Crises$
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Jerome L. Stein

Print publication date: 2006

Print ISBN-13: 9780199280575

Published to Oxford Scholarship Online: May 2006

DOI: 10.1093/0199280576.001.0001

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Stochastic optimal control model of short-term debt 1

Stochastic optimal control model of short-term debt 1

Chapter:
(p.45) 2 Stochastic optimal control model of short-term debt1
Source:
Stochastic Optimal Control, International Finance, and Debt Crises
Author(s):

Jerome L. Stein (Contributor Webpage)

Publisher:
Oxford University Press
DOI:10.1093/0199280576.003.0002

Data on the credit rating of bonds issued in the first half of the 1990s suggest that investors in emerging market securities paid little attention to credit risk, or that they were comfortable with the high level of credit risk that they were incurring. This chapter develops a paradigm for intertemporal optimization under uncertainty in a finite horizon discrete time context, with the constraint that there be no default on short-term foreign currency denominated debt. The object is to select consumption, investment, and the resulting short-term debt in the first period to maximize the expected present value of the utility of consumption over both periods. The constraint is that regardless of the state of nature in the second period, there will be no default on the debt.

Keywords:   optimal short-term debt, intertemporal optimization, debt default, credit rating, bonds

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