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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

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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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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
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Handle: RePEc:bca:bocawp:04-20

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Related research
Keywords: Development economics; Financial markets; International topics;

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Find related papers by JEL classification:
F30 - International Economics - - International Finance - - - General
F34 - International Economics - - International Finance - - - International Lending and Debt Problems
F49 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Other
G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
O16 - Economic Development, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November. [Downloadable!] (restricted)
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    Other versions:
    • 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. [Downloadable!]
  4. Ricardo J. Caballero, 2003. "The Future of the IMF," American Economic Review, American Economic Association, vol. 93(2), pages 31-38, May. [Downloadable!]
  5. Stanley Fischer, 2002. "Financial Crises and Reform of the International Financial System," NBER Working Papers 9297, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  7. Kenneth M. Kletzer & Brian D. Wright, 2000. "Sovereign Debt as Intertemporal Barter," American Economic Review, American Economic Association, vol. 90(3), pages 621-639, June. [Downloadable!] (restricted)
    Other versions:
  8. Kenneth A. Froot & David S. Scharfstein & Jeremy C. Stein, 1990. "LDC Debt: Forgiveness, Indexation, and Investment Incentives," NBER Working Papers 2541, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  9. Paul R. Krugman, 1989. "Financing vs. Forgiving a Debt Overhang," NBER Working Papers 2486, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  10. 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. [Downloadable!] (restricted)
  11. 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. [Downloadable!] (restricted)
  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. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. 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. [Downloadable!]
  2. C. Bora Durdu, 2006. "Are Indexed Bonds a Remedy for Sudden Stops?," Computing in Economics and Finance 2006 11, Society for Computational Economics. [Downloadable!]
  3. Salih N. Neftci & Y. Lu, 2008. "Financial Instruments to Hedge Commodity Price Risk for Developing Countries," IMF Working Papers 08/6, International Monetary Fund. [Downloadable!]
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