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Designing GDP-Linked Bonds with Default

Author

Listed:
  • John Leventides
  • Evangelos Melas
  • Costas Poulios
  • Paraskevi Boufounou
  • Rena Artemis Leventides

Abstract

We develop and present a model for pricing GDP-linked bonds that takes into account both GDP fluctuations and fiscal default. The indexation is based on the size of GDP deviations from the trend and default is based on the size of sovereign debt. We consider a mapping of these instruments to normal fixed-income securities, and a bond equivalent yield is calculated as well as a default premium. We construct various indexed bond products with different coupon variations and we price them via Monte-Carlo simulations for the case of Greece. The model can be applied to other countries provided that the data are adjusted. One of the main results is that GDP-linked bonds are more conducive to debt management. In particular, replacing conventional bond instruments with carefully designed GDP-linked bonds of equivalent yield can lead to lower terminal values of debt-to-GDP ratio, provided that the macroeconomic environment is the same.

Suggested Citation

  • John Leventides & Evangelos Melas & Costas Poulios & Paraskevi Boufounou & Rena Artemis Leventides, 2021. "Designing GDP-Linked Bonds with Default," Applied Economics Quarterly (formerly: Konjunkturpolitik), Duncker & Humblot GmbH, Berlin, vol. 67(4), pages 311-335.
    • Handle: RePEc:dah:aeqaeq:v67_y2021_i4_q4_p311-335
    DOI: 10.3790/aeq.67.4.311
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    More about this item

    Keywords

    GDP-linked bonds; plain vanilla bonds; pricing; debt management; default;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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