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The case for GDP-indexed bonds

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Author Info
Eduardo Borensztein
Paolo Mauro

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Abstract

"This paper seeks to revive the case for countries to insure against economic growth slowdowns by issuing bonds indexed to the rate of growth of GDP. We show that GDP-indexed bonds could provide substantial benefits in reducing the likelihood of default crises and allowing countries to avoid pro-cyclical fiscal policies. We simulate the effects of GDP-indexed bonds under different assumptions about fiscal policy reaction functions and their output effects and find that they could substantially reduce the likelihood of debt/GDP paths becoming explosive. The insurance premium would likely be small, because cross-country comovement of GDP growth rates is low and cross-country GDP growth risk is thus largely diversifiable for an investor holding a portfolio of GDP-indexed bonds. Potential obstacles to the emergence of a market for these bonds include the verifiability of GDP data, the trade-off between insurance and moral hazard, and the need for liquidity. Theory and past experience suggest that financial innovation often requires official intervention and its timing and form are difficult to predict. We discuss institutional fixes and suggest an approach for attempting to start up a market." Copyright © CEPR, CES, MSH, 2004..

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File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1468-0327.2004.00121.x
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Publisher Info
Article provided by CEPR, CES, MSH in its journal Economic Policy.

Volume (Year): 19 (2004)
Issue (Month): 38 (04)
Pages: 165-216
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Handle: RePEc:bla:ecpoli:v:19:y:2004:i:38:p:165-216

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  2. Alexandra Tabova, 2005. "On the feasibility and desirability of GDP-indexed concessional lending," Department of Economics Working Papers 0509, Department of Economics, University of Trento, Italia. [Downloadable!]
  3. Stephany Griffith-Jones & Krishnan Sharma, 2006. "GDP-Indexed Bonds: Making It Happen," Working Papers 21, United Nations, Department of Economics and Social Affairs. [Downloadable!]
  4. Juan Carlos Hatchondo & Leonardo Martinez & Horacio Sapriza, 2007. "Quantitative models of sovereign default and the threat of financial exclusion," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 251-286. [Downloadable!]
  5. von Furstenberg, George M., 2004. "Consumption Smoothing Across States and Time : International Insurance vs. Foreign Loans," Discussion Paper Series 1: Economic Studies 2004,13, Deutsche Bundesbank, Research Centre. [Downloadable!]
  6. Olivier Jeanne & Jeromin Zettelmeyer, 2004. "The Mussa Theorem: and Other Results on IMF Induced Moral Hazard," IMF Working Papers 04/192, International Monetary Fund. [Downloadable!]
  7. Barry Eichengreen, 2006. "Insurance Underwriter or Financial Development Fund: What Role for Reserve Pooling in Latin America?," NBER Working Papers 12451, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Jean Imbs & Paolo Mauro, 2007. "Pooling Risk Among Countries," IMF Working Papers 07/132, International Monetary Fund. [Downloadable!]
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  9. Giorgio Basevi & Lorenzo Pecchi & Gustavo Piga, 2005. "Parallel Monies, Parallel Debt: Lessons from the EMU and Options for the New EU," CEIS Research Paper 68, Tor Vergata University, CEIS. [Downloadable!]
  10. Marcos Chamon & Paolo Mauro, 2005. "Pricing Growth-Indexed Bonds," IMF Working Papers 05/216, International Monetary Fund. [Downloadable!]
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  11. Claessens, Stijn, 2005. "Taking stock of risk management techniques for sovereigns," Policy Research Working Paper Series 3570, The World Bank. [Downloadable!]
  12. Guimarães, Bernardo, 2007. "Optimal external debt and default," CEPR Discussion Papers 6035, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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