Debt-Maturity Management with Liquidity Costs

Abstract

We document the presence of significant liquidity costs in Spanish sovereign debt auctions: the larger the auctioned amounts, the lower the issuance price relative to secondary-market prices. Motivated by this evidence, we characterize the optimal debt-maturity management problem of a government that issues finite-maturity bonds of various maturities, in the presence of such liquidity costs. This characterization allows us to quantify how the government’s relative impatience, yield-curve riding, and expenditure smoothing shape the optimal debt-maturity distribution. The model can rationalize actual debt-management practices.