Stochastic Optimal Control, International Finance and Debt

Wendell Fleming and Jerome Stein

No 744, CESifo Working Paper Series from CESifo

Abstract: We use stochastic optimal control-dynamic programming (DP) to derive the optimal foreign debt/net worth, consumption/net worth, current account/net worth, and endogenous growth rate in an open economy. Unlike the literature that uses an Intertemporal Budget Constraint (IBC) or the Maximum Principle, the DP approach does not require perfect foresight or certainty equivalence. Errors of measurement and the effects of unanticipated shocks are corrected in an optimal manner. We contrast the DP and IBC approaches, show how the results of the dynamic programming approach can be interpreted in a traditional simple mean-variance/Tobin-Markowitz context, and explain why our results are generalizations of the Merton model.

Keywords: stochastic optimal control; foreign debt; international finance; vulnerability to external shocks; sustainable current account deficits (search for similar items in EconPapers)
Date: 2002
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Citations: View citations in EconPapers (2)

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Related works:
Working Paper: Stochastic Optimal Control, International Finance and Debt (2010)
Journal Article: Stochastic optimal control, international finance and debt (2004)
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Persistent link: https://EconPapers.repec.org/RePEc:ces:ceswps:_744

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