Optimal Capital Buffers of Sovereign Debt Management Offices

We present a framework of sovereign debt issuances and precautionary capital buffers. In a setting where sovereign debt managers are confronted with budget risk and intertemporal funding is costly, the sovereign may issue debt in excess of expected funding needs - a capital buffer - as a measure of self-insurance. We provide an empirical assessment of optimal capital buffers for a panel of European countries and derive policy recommendations. For realistic parameters, our model suggests capital buffers in a range from 0.19% to 1.41% of the gross domestic product if the debt manager’s budget predictions are based on an estimate of the deficit’s unconditional mean. If debt managers can predict future deficits at least to some extent, high budget forecast errors become less likely and capital buffer holdings decrease. Our model suggest that optimal capital buffers remain positive and lie between 0.04% to 0.19% of the gross domestic product.