On Optimal Foreign Borrowing

Seung-Gwan Baek
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Seung-Gwan Baek: Hongik University

Korean Economic Review, 2002, vol. 18, 215-231

Abstract: This paper derives an optimal borrowing rule from an intertemporal optimizing model in which uncertainty and risk premium are explicitly incorporated. The optimal borrowing rule is that the risk-adjusted marginal product of capital, net of depreciation, must be equal to the risk-adjusted, country-specific risk premium-adjusted interest rate of borrowing. The key difference between the optimal borrowing rule in earlier studies and the revised rule is that optimality criteria in foreign indebtedness should be associated with the agent's risk aversion and the size of the stochastic disturbances in profit flows. The revised rule demonstrates that uncertainties may play an important role in deciding the relationship between capital stock and foreign debt stock and between domestic saving and foreign saving in heavily indebted economies.

Keywords: Optimal borrowing; uncertainty; risk premium (search for similar items in EconPapers)
JEL-codes: F34 O16 (search for similar items in EconPapers)
Date: 2002
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