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Commodity-Linked Bonds: A Potential Means for Less-Developed Countries to Raise Foreign Capital

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Author Info

  • Joseph Atta-Mensah

Abstract

The author suggests that commodity-linked bonds could provide a potential means for less-developed countries (LDCs) to raise money on the international capital markets, rather than through standard forms of financing. The issue of this type of bond could provide an opportunity for commodity-producing LDCs to hedge against fluctuations in their export earnings. The author's results show that the value of a commodity-linked bond increases as the price of the commodity indexed to the bond rises; this suggests that, if LDCs had issued debt contracts that were tied to their main export commodities, then their debt load would decline along with plummeting export prices (or export revenues). A simple portfolio rule derived by the author suggests that LDCs should issue more commodity-linked bonds than conventional debt if the variance of the portfolio is greater than twice the spread between the expected total return of the conventional debt and the commodity-linked bond. This rule supports the view that, if more of the LDCs' debt were issued in the form of commodity-linked bonds, then the debt-service payment of the LDCs would decline along with export prices (or export revenues), thus lightening their debt load.

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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 04-20.

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Length: 43 pages
Date of creation: 2004
Date of revision:
Handle: RePEc:bca:bocawp:04-20

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Keywords: Development economics; Financial markets; International topics;

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References

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  1. R. C. Merton, 1970. "Optimum Consumption and Portfolio Rules in a Continuous-time Model," Working papers 58, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
  3. Rudiger Dornbusch & Thomas S. Johnson & Anne O. Krueger, 1988. "Our LDC Debts," NBER Chapters, in: The United States in the World Economy, pages 161-214 National Bureau of Economic Research, Inc.
  4. Ricardo J. Caballero, 2003. "The Future of the IMF," American Economic Review, American Economic Association, vol. 93(2), pages 31-38, May.
  5. Kletzer, Kenneth M. & Wright, Brian D., 1998. "Sovereign Debt as Intertemporal Barter," Center for International and Development Economics Research, Working Paper Series qt4qg3c42v, Center for International and Development Economics Research, Institute for Business and Economic Research, UC Berkeley.
  6. Kenen, Peter B, 1990. "Organizing Debt Relief: The Need for a New Institution," Journal of Economic Perspectives, American Economic Association, vol. 4(1), pages 7-18, Winter.
  7. Stanley Fischer, 2002. "Financial Crises and Reform of the International Financial System," NBER Working Papers 9297, National Bureau of Economic Research, Inc.
  8. Paul R. Krugman, 1989. "Financing vs. Forgiving a Debt Overhang," NBER Working Papers 2486, National Bureau of Economic Research, Inc.
  9. Ryozo Miura & Hiroaki Yamauchi, 1998. "The Pricing Formula for Commodity-Linked Bonds with Stochastic Convenience Yields and Default Risk," Asia-Pacific Financial Markets, Springer, vol. 5(2), pages 129-158, May.
  10. Froot, Kenneth A & Scharfstein, David S & Stein, Jeremy C, 1989. " LDC Debt: Forgiveness, Indexation, and Investment Incentives," Journal of Finance, American Finance Association, vol. 44(5), pages 1335-50, December.
  11. Anne Krueger, 2003. "Sovereign Debt Restructuring: Messy or Messier?," American Economic Review, American Economic Association, vol. 93(2), pages 70-74, May.
  12. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
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Citations

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Cited by:
  1. C. Bora Durdu, 2006. "Are Indexed Bonds a Remedy for Sudden Stops?," Computing in Economics and Finance 2006 11, Society for Computational Economics.
  2. Anubha Dhasmana, 2008. "Welfare Gains of Aid Indexation in Small Open Economies," IMF Working Papers 08/101, International Monetary Fund.
  3. Lu, Yinqiu & Neftci, Salih, 2008. "Financial instruments to hedge commodity price risk for developing countries," Journal of Financial Transformation, Capco Institute, vol. 24, pages 137-143.
  4. Samuel Malone, 2005. "Managing Default Risk for Commodity Dependent Countries: Price Hedging in an Optimizing Model," Economics Series Working Papers 246, University of Oxford, Department of Economics.

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