Commonwealth Secretariat Discussion Paper

The Discussion Paper series raises awareness of topics that are of importance to Commonwealth work programmes. Discussion Papers explore an issue relating to research or programme activities and provoke debate on it. The intended readership is researchers and policy advisers.


Risk Management of Contingent Liabilities and Public Debt

A New Approach for Commonwealth Member Countries

The subject matter of sovereign contingent liability (CL) risk management has been receiving increasing attention, since it is widely acknowledged that it poses potential hidden fiscal risks. These risks arise as a result of the uncertainty of: (i) whether the CL risk event(s) will materialise; (ii) the precise timing of the occurrence of the event leading to ownership of an obligation; and (iii) the exact amount of this obligation. Notwithstanding this, it is unsurprising that more countries are making use of contingent liabilities. The primary reason for this is that they are balance sheet neutral (from a cash-based accounting perspective), which provides the incentive to use this mechanism over direct lending to achieve policy objectives. This paper presents a framework within which active risk management of contingent liabilities can be undertaken in a manner that covers the lifespan of the liability and which also incorporates the portfolio effects of other liabilities. This is achieved by providing various frameworks for the calculation of provisions, as well as a general framework for CL risk management.


Keywords: public debt management, contingent liability, risk management
JEL: G32: Financial Economics / Corporate Finance and Governance / Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill; H63: Public Economics / National Budget, Deficit, and Debt / National Debt; Debt Management; Sovereign Debt
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