Optimal maturity of government debt without state contingent bonds

This paper shows that state contingent debt can be synthetically constructed using non-contingent debt of different maturities. A main policy implication of this principle is that the Ramsey allocation with complete markets can be sustained with non-contingent debt only by properly managing its maturity structure. The numerical experiments, however, suggest that this policy implication ought to be taken with care. We find that the debt positions that sustain the Ramsey allocation are very high (on the order of it few hundred times total GDP for a very simple four state economy) and increasing in the number of states. In addition, they are very sensitive to small variations in the parameters of the model. (C) 2003 Elsevier B.V. All rights reserved.