Managing Public Portfolios

We develop a unified framework for optimal management of public portfolios for a general class of macro-finance models imposing very few restrictions on households’ risk and liquidity preferences or market structure for financial assets. Small-noise expansions to first-order conditions for a Ramsey plan can be reorganized into a formula for an optimal portfolio of government financial assets that isolates four motives balanced at an optimum: (1) hedging interest rate risk, (2) hedging primary deficit risk, (3) supplying liquid assets, and (4) internalizing equilibrium effects of public policies on financial asset prices. We directly calibrate quantitative measures of these four motives. Hedging interest rate risk plays a dominant role in shaping an optimal portfolio of financial assets for the U.S. federal government. *We thank Marios Angeletos and Hanno Lustig for discussions of the earlier draft of this paper, audiences at Chicago, UPenn, Bank of Portugal, Toulouse for feedback, and Leo Aparisi De Lannoy and Jiawei Fan for excellent research assisance. Bhandari, Evans, and Golosov thank the NSF for support (grant #36354.00.00.00).