Optimal Capital Buffers of Sovereign Debt Management Offices

Abstract

We model a sovereign debt manager who has a prediction of the budget deficit and needs to raise debt at the beginning of the budget period. In this setting, the sovereign may issue debt in excess of expected funding needs – a precautionary cash buffer – as a measure of self-insurance against the potential cost of inter-temporal funding. Based on budget deficit predictions that are reported under the EU’s Stability and Growth Pact and Excessive Deficit Procedure, as well as historical budget deficit data, we provide an empirical assessment of optimal cash buffers for a panel of EU countries.