SAFE Research Seminar: Alfons J. Weichenrieder (Goethe University)
Title: Public Debt Management and Interest Rate Swaps
Speaker: Alfons J. Weichenrieder, Goethe University
(joint with Johannes Kasinger and Lukas Nöh, both Goethe University).
Abstract: Several countries across different levels of government extensively use interest rate swaps to manage the maturity of the public debt portfolio and to hedge against future interest rate fluctuations. This paper analyses the optimal decision of a government that faces exogenous interest rate shocks and may use short-term debt, long-term debt, and swap contracts to finance an inherited stock of public debt. In such a framework, hedging of interest rate risk and the use of interest rate swaps may be beneficial strategies in order to decrease the volatility of future taxation. However, after using historical interest rate data for different time horizons and currencies to parameterize our stylized three-period model, simulations show that the optimal amount of interest rate swaps is usually very small or zero, even if hedging through interest rate swaps comes with only a minimal cost. This finding can be attributed to the fact that the interest rate risk of the state, as a debtor, can be neutralized by the opposite risk of taxpayers in their function as creditors.
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