A Cheap Lunch for Emerging Markets: Removing International Financial Market Imperfections with Modern Financial Instruments

Summary This paper develops a market-based procedure to significantly reduce the indebtedness of emerging markets by applying an asset-backed security approach to a pool of emerging market bonds. In an extensive simulation study based on historical data, the cumulated interest savings over a horizon of 10 years amount to about 20% of the credit sum on average (with a standard deviation of 8%) and up to 44% for individual countries--dependent on the internal distribution of the surplus. The theoretical structure of the transaction is explicitly derived in cooperation with professionals from major commercial banks, and it implies only negligible implementation cost. The implementation requires neither institutional reforms nor debt forgiveness, but can supplement or substitute previous measures.