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The Lucas and Stokey (1983) economy without capital is used to exhibit features of the Lucas and Stokey model of optimal taxation, and show how they compare with Barro's (1979) tax‐smoothing model. Computation of optimal fiscal policies for Lucas and Stokey's model requires repeated evaluations of the present value of the government's surplus, an object formally equivalent to an asset price. The functional equation for an asset price is typically difficult to solve. A linear quadratic version of Lucas and Stokey's model is specified, which makes both asset pricing computations and optimal fiscal policy calculations easy. Martingale returns on government debt are discussed, and examples and extensions of Lucas and Stokey's model given. Two appendices describe and discuss: the key steps for two basic kinds of stochastic process (a stochastic first‐order linear difference equation and a Markov chain), and time consistency and the structure of debt. Lastly, details are given of the appropriate MATLAB programs.

The emerging country experience was in contrast to that of the advanced core countries, which were financially mature, had credibility, could issue bonds denominated in terms of their own currency, and where there were few crises. This chapter examines whether these very different debt structures might play a role in explaining the difference in crisis incidence, and also explores whether debt-management policies that created or alleviated balance sheet mismatches mattered. It looks at whether poor reputation and accumulated default experience was a problem, as hypothesized by Carmen Reinhart, Kenneth Rogoff, and Miguel Savastano in their work on debt intolerance. The chapter also develops a database to identify and distinguish original sin and balance sheet crises from more traditional currency and banking crises for roughly thirty countries (both advanced and emerging) from 1880 to 1913.

Chapter 4 illustrated the factors that can undermine debt sustainability; this chapter builds on that by exploring the role of debt managers in reducing these risks. The chapter begins with the motives of the debt managers, including to minimize the risk–cost trade-off; but also bigger picture motives, such as the allocation of risk between the public and private sector. It also shows how the composition of sovereign debt can have important macroeconomic implications, such as via the monetary policy transmission mechanism. The chapter details the risks from maturity, currency, and residency, including the “original sin” problem faced by some countries. It concludes with a discussion of the role of debt managers in pursuing other objectives, such as financial deepening.

Securitized debt markets play a vital role in financial markets in risk-sharing and creating alternative financing sources, which provide benefits for both borrower and lenders. This chapter describes the main characteristics of securitized debt and securitized debt instruments. Major securitized debt instruments are mortgage-backed securities (MBSs) including residential mortgage-backed securities (RMBSs) and commercial mortgage-backed securities (CMBSs) as well as asset backed commercial paper (ABCP) and collateralized debt obligations (CDOs). The characteristics of these securities, their associated benefits and uses, and the risk factors that determine the performance of securitized debt instruments are covered. The evolution and size of these securitized markets is also discussed. Overall, the chapter indicates that securitized markets help originators in transferring risks and monetizing illiquid assets and aid investors by providing an efficient mechanism for portfolio diversification and ability to better adjust their investments to their risk preferences.