This paper analyzes the optimal structure of government debt in a stochastic environment. In a model with distortionary taxes, the government should smooth tax rates over states of nature as well as over time. Government liabilities should be structured to hedge against macroeconomic shocks that affect the government budget. The optimal structure of government liabilities generally includes some "risky" securities that are state-contingent in real terms. The empirical part of the paper tests for tax smoothing and then studies state contingencies implemented by some specific securities, including nominal debt, long-term bonds, equity, and foreign-currency debt. Copyright 1990 by American Economic Association.

1995). Our research examines whether the expansion of U.S. investment in foreign equities and the change in the composition of the foreign portfolio over time is consistent with standard models of international portfolio choice. To answer this question, we combine data on cross-border transactions in foreign equities with data on equity returns. Our approach has three important advantages over previous tests of models of international portfolio choice. First, we bring data on asset prices as well as data on the quantities of assets purchased to bear in the empirical tests.' Second, our testing procedure is robust to time-invariant hedge factors. This is because net purchases reflect changes in portfolio weights, and constant hedge factors that might explain home bias in levels do not affect the adjustment of the port