A tale of two debt crises: a stochastic optimal control analysis

Jerome Stein

Economics - The Open-Access, Open-Assessment E-Journal (2007-2020), 2010, vol. 4, No 2010-3, 24 pages

Abstract: Creditors, banks and bank regulators should evaluate whether a borrower is likely to default. I apply several techniques in the extensive mathematical literature of stochastic optimal control/dynamic programming to derive an optimal debt in an environment where there are risks on both the asset and liabilities sides. The vulnerability of the borrowing firm to shocks from either the return to capital, the interest rate or capital gain, increases in proportion to the difference between the Actual and Optimal debt ratio, called the excess debt. As the debt ratio exceeds the optimum, default becomes ever more likely. This paper is 'A Tale of Two Crises' because the same analysis is applied to the agricultural debt crisis of the 1980s and to the subprime mortgage crisis of 2007. A measure of excess debt is derived, and we show that it is an early warning signal of a crisis in both cases

Keywords: Optimization; banking; stochastic optimal control; agriculture debt crisis; subprime mortgage crisis (search for similar items in EconPapers)
JEL-codes: C61 D81 D91 D92 (search for similar items in EconPapers)
Date: 2010
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

Downloads: (external link)
http://dx.doi.org/10.5018/economics-ejournal.ja.2010-3
https://www.econstor.eu/bitstream/10419/29631/1/616556667.pdf (application/pdf)

Related works:
Working Paper: A tale of two debt crises: a stochastic optimal control analysis (2009)
Working Paper: A Tale of Two Debt Crises: A Stochastic Optimal Control Analysis (2008)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:zbw:ifweej:20103

DOI: 10.5018/economics-ejournal.ja.2010-3

Access Statistics for this article

Economics - The Open-Access, Open-Assessment E-Journal (2007-2020) is currently edited by Dennis J. Snower

More articles in Economics - The Open-Access, Open-Assessment E-Journal (2007-2020) from Kiel Institute for the World Economy (IfW Kiel) Contact information at EDIRC.
Bibliographic data for series maintained by ZBW - Leibniz Information Centre for Economics (econstor@zbw-workspace.eu).