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Reviving the Case for GDP-Indexed Bonds

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Author Info

  • Eduardo Borensztein
  • Paolo Mauro

Abstract

This paper seeks to revive the case for countries to self-insure against economic growth slowdowns by issuing GDP-indexed bonds. 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 that debt/GDP paths become 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. The paper discusses institutional fixes and suggests an approach to attempting to start up a market.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Policy Discussion Papers with number 02/10.

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Length: 25
Date of creation: 01 Sep 2002
Date of revision:
Handle: RePEc:imf:imfpdp:02/10

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Related research

Keywords: Emerging markets; bonds; debt; indexed bonds; interest; bond; external debt; stock returns; fiscal policy; debt crises; debt contracts; sovereign debt; moral hazard; financial innovation; default risk; financial markets; financial instruments; payments; stock market; public debt; taxes; debt overhang; creditors; hedging; repayment; restructuring; international financial markets; debtors; sovereign bonds; index bond; market liquidity; currency crisis; emerging market bonds; access to international financial markets; obligations; foreign debt; financial institutions; term bonds; financial intermediaries; indexed bond; international capital; debt sustainability; financial instability; refinance; long-term bonds; debt instruments; liabilities; bondholders; international capital markets; stock market fluctuations; debt obligations; financial stability; debt forgiveness; deficits; brady bonds; rate bond;

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