The Optimal Control of Government Stabilization Funds

Abel Cadenillas and Ricardo Huamán-Aguilar
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Abel Cadenillas: Department of Mathematical and Statistical Sciences, University of Alberta, Central Academic Building 639, Edmonton, AB T6G 2G1, Canada
Ricardo Huamán-Aguilar: Department of Economics, Pontificia Universidad Católica del Perú, Av. Universitaria 1801, San Miguel, Lima 32, Peru

Mathematics, 2020, vol. 8, issue 11, 1-24

Abstract: We study the optimal control of a government stabilization fund, which is a mechanism to save money during good economic times to be used in bad economic times. The objective of the fund manager is to keep the fund as close as possible to a predetermined target. Accordingly, we consider a running cost associated with the difference between the actual fiscal fund and the fund target. The fund manager exerts control over the fund by making deposits in or withdrawals from the fund. The withdrawals are used to pay public debt or to finance government programs. We obtain, for the first time in the literature, the optimal band for the government stabilization fund. Our results are of interest to practitioners. For instance, we find that the higher the volatility, the larger the size of the optimal band. In particular, each country and state should have its own optimal fund band, in contrast to the “one-size-fits-all” approach that is often used in practice.

Keywords: singular stochastic control; stochastic optimization; optimal government stabilization fund; macrofinance; quantitative risk management (search for similar items in EconPapers)
JEL-codes: C (search for similar items in EconPapers)
Date: 2020
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