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An Integrated Approach to Cost-Risk Analysis in Public Debt Management

Public debt management requires accurate analysis of the cost and the risk associated with feasible choices of public debt portfolios. The Italian Treasury employs an in-house, custom-built set of models and software tools aimed at selecting portfolios of securities that satisfy the government’s borrowing needs while fulfilling all the relevant regulatory constraints, thereby delivering suitable tradeoffs between cost and risk on an efficient frontier. In this paper, we present a description of the approach followed by the Italian Treasury, including the study of the dynamics of the cash flow generated by the public debt and the development of stochastic models for the evolution of the main risk factors (i.e., interest rates and inflation). Then, we describe how several dynamic metrics of cost and risks are integrated within a scenario generator in a modular software package called SAPE (Sistema Analisi Portafogli di Emissione – System for the Analysis of Public Debt Issuances). This system supports the public debt manager by providing accurate quantitative estimates of the expected effects of their choices taking into account not only shocks to interest rate curves but also exogenous forecasts about the future behavior of the risk factors. The software can also be used as an accounting tool for the outstanding securities of the Italian public debt, and includes various satellite modules for the evaluation of other relevant metrics, such as the Credit Value Adjustment for derivative instruments.