IDEAS home Printed from https://ideas.repec.org/p/rug/rugwps/22-1056.html
   My bibliography  Save this paper

Optimal GDP-indexed Bonds

Author

Listed:
  • Yasin Kürsat Önder

Abstract

I investigate the introduction of GDP-indexed bonds as an additional source of government borrowing in a quantitative default model. The idea of linking debt payments to developments in GDP resurfaced with the 1980s debt crisis and peaked with the COVID-19 outbreak. I show that the gains from this idea depend on the underlying indexation method and are highest if payments are symmetrically tied to developments in GDP. Optimized indexed debt can eradicate default risk, halve consumption volatility, and increase asset prices while raising the government’s debt balances. These changes occur because an optimally chosen indexation method does a better job at completing the markets.

Suggested Citation

  • Yasin Kürsat Önder, 2022. "Optimal GDP-indexed Bonds," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 22/1056, Ghent University, Faculty of Economics and Business Administration.
    • Handle: RePEc:rug:rugwps:22/1056
    as

    Download full text from publisher

    File URL: http://wps-feb.ugent.be/Papers/wp_22_1056.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Gelos, R. Gaston & Sahay, Ratna & Sandleris, Guido, 2011. "Sovereign borrowing by developing countries: What determines market access?," Journal of International Economics, Elsevier, vol. 83(2), pages 243-254, March.
    2. Juan Carlos Hatchondo & Leonardo Martinez & Horacio Sapriza, 2010. "Quantitative properties of sovereign default models: solution methods," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 13(4), pages 919-933, October.
    3. Javier Bianchi & Juan Carlos Hatchondo & Leonardo Martinez, 2018. "International Reserves and Rollover Risk," American Economic Review, American Economic Association, vol. 108(9), pages 2629-2670, September.
    4. Fernando A. Broner & Guido Lorenzoni & Sergio L. Schmukler, 2013. "Why Do Emerging Economies Borrow Short Term?," Journal of the European Economic Association, European Economic Association, vol. 11, pages 67-100, January.
    5. Franklin Allen, Douglas Gale, 1988. "Optimal Security Design," Review of Financial Studies, Society for Financial Studies, vol. 1(3), pages 229-263.
    6. Hatchondo, Juan Carlos & Martinez, Leonardo, 2009. "Long-duration bonds and sovereign defaults," Journal of International Economics, Elsevier, vol. 79(1), pages 117-125, September.
    7. Stefano G. Athanasoulis & Robert J. Shiller, 2001. "World Income Components: Measuring and Exploiting Risk-Sharing Opportunities," American Economic Review, American Economic Association, vol. 91(4), pages 1031-1054, September.
    8. Robert J. Shiller, 2012. "Finance and the Good Society," Economics Books, Princeton University Press, edition 1, number 9652.
    9. Aguiar, Mark & Gopinath, Gita, 2006. "Defaultable debt, interest rates and the current account," Journal of International Economics, Elsevier, vol. 69(1), pages 64-83, June.
    10. Juan J. Cruces & Christoph Trebesch, 2013. "Sovereign Defaults: The Price of Haircuts," American Economic Journal: Macroeconomics, American Economic Association, vol. 5(3), pages 85-117, July.
    11. Juan Carlos Hatchondo & Leonardo Martinez, 2012. "On the benefits of GDP-indexed government debt: lessons from a model of sovereign defaults," Economic Quarterly, Federal Reserve Bank of Richmond, vol. 98(2Q), pages 139-157.
    12. Hart, Oliver D., 1975. "On the optimality of equilibrium when the market structure is incomplete," Journal of Economic Theory, Elsevier, vol. 11(3), pages 418-443, December.
    13. Eduardo Borensztein & Paolo Mauro, 2004. "The case for GDP-indexed bonds [‘World income components: measuring and exploiting risk-sharing opportunities’]," Economic Policy, CEPR, CESifo, Sciences Po;CES;MSH, vol. 19(38), pages 166-216.
    14. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
    15. Gonçalo Pina, 2022. "State-Contingent Government Debt: a New Database," Credit and Capital Markets – Kredit und Kapital, Duncker & Humblot, Berlin, vol. 55(1), pages 35-66.
    16. Fernando Alvarez & Urban J. Jermann, 2000. "Efficiency, Equilibrium, and Asset Pricing with Risk of Default," Econometrica, Econometric Society, vol. 68(4), pages 775-798, July.
    17. Durdu, Ceyhun Bora, 2009. "Quantitative implications of indexed bonds in small open economies," Journal of Economic Dynamics and Control, Elsevier, vol. 33(4), pages 883-902, April.
    18. Cristina Arellano, 2008. "Default Risk and Income Fluctuations in Emerging Economies," American Economic Review, American Economic Association, vol. 98(3), pages 690-712, June.
    19. Juan Carlos Hatchondo & Leonardo Martinez & Horacio Sapriza, 2010. "Quantitative properties of sovereign default models: solution methods matter," Working Paper 10-04, Federal Reserve Bank of Richmond.
    20. Guillermo A. Calvo & Alejandro Izquierdo & Ernesto Talvi, 2006. "Sudden Stops and Phoenix Miracles in Emerging Markets," American Economic Review, American Economic Association, vol. 96(2), pages 405-410, May.
    21. Stephany Griffith-Jones & Krishnan Sharma, 2006. "GDP-Indexed Bonds: Making It Happen," Working Papers 21, United Nations, Department of Economics and Social Affairs.
    22. repec:oup:ecpoli:v:19:y:2004:i:38:p:165-216 is not listed on IDEAS
    23. Krugman, Paul, 1988. "Financing vs. forgiving a debt overhang," Journal of Development Economics, Elsevier, vol. 29(3), pages 253-268, November.
    24. 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 1335-1350, December.
    25. Vasicek, Oldrich Alfonso, 1977. "Abstract: An Equilibrium Characterization of the Term Structure," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 12(4), pages 627-627, November.
    26. Mr. Luca A Ricci & Mr. Marcos d Chamon & Alejo Costa, 2008. "Is There a Novelty Premium on New Financial Instruments? The Argentine Experience with GDP-Indexed Warrants," IMF Working Papers 2008/109, International Monetary Fund.
    Full references (including those not matched with items on IDEAS)

    Citations

    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Optimal GDP-indexed Bonds
      by Christian Zimmermann in NEP-DGE blog on 2022-12-23 05:04:59

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Juan Carlos Hatchondo & Leonardo Martinez & César Sosa-Padilla, 2016. "Debt Dilution and Sovereign Default Risk," Journal of Political Economy, University of Chicago Press, vol. 124(5), pages 1383-1422.
    2. Juan Carlos Hatchondo & Leonardo Martinez & Yasin Kürsat Önder & Francisco Roch, 2022. "Sovereign Cocos," Working Papers 139, Red Nacional de Investigadores en Economía (RedNIE).
      • Juan Carlos Hatchondo & Mr. Leonardo Martinez & Kursat Onder & Mr. Francisco Roch, 2022. "Sovereign Cocos," IMF Working Papers 2022/078, International Monetary Fund.
    3. Juan Carlos Hatchondo & Leonardo Martinez & Francisco Roch, 2012. "Fiscal rules and the sovereign default premium," Working Paper 12-01, Federal Reserve Bank of Richmond.
    4. Aguiar, Mark & Amador, Manuel, 2014. "Sovereign Debt," Handbook of International Economics, in: Gopinath, G. & Helpman, . & Rogoff, K. (ed.), Handbook of International Economics, edition 1, volume 4, chapter 0, pages 647-687, Elsevier.
    5. Carré, Sylvain & Cohen, Daniel & Villemot, Sébastien, 2019. "The sources of sovereign risk: a calibration based on Lévy stochastic processes," Journal of International Economics, Elsevier, vol. 118(C), pages 31-43.
    6. Javier Bianchi & Juan Carlos Hatchondo & Leonardo Martinez, 2018. "International Reserves and Rollover Risk," American Economic Review, American Economic Association, vol. 108(9), pages 2629-2670, September.
    7. Lopez-Martin, Bernabe & Leal, Julio & Martinez Fritscher, Andre, 2019. "Commodity price risk management and fiscal policy in a sovereign default model," Journal of International Money and Finance, Elsevier, vol. 96(C), pages 304-323.
    8. Hatchondo, Juan Carlos & Martinez, Leonardo & Onder, Yasin Kursat, 2017. "Non-defaultable debt and sovereign risk," Journal of International Economics, Elsevier, vol. 105(C), pages 217-229.
    9. Mihalache, Gabriel, 2020. "Sovereign default resolution through maturity extension," Journal of International Economics, Elsevier, vol. 125(C).
    10. Leonardo Martinez & Juan Hatchondo, 2017. "Sovereign Cocos and the Reprofiling of Debt Payments," 2017 Meeting Papers 1435, Society for Economic Dynamics.
    11. Sosa-Padilla, César & Sturzenegger, Federico, 2023. "Does it matter how central banks accumulate reserves? Evidence from sovereign spreads," Journal of International Economics, Elsevier, vol. 140(C).
    12. Dvorkin, Maximiliano & Sánchez, Juan M. & Sapriza, Horacio & Yurdagul, Emircan, 2022. "Improving sovereign debt restructurings," Journal of Economic Dynamics and Control, Elsevier, vol. 139(C).
    13. Passadore, Juan & Xu, Yu, 2022. "Illiquidity in sovereign debt markets," Journal of International Economics, Elsevier, vol. 137(C).
    14. Ricardo Sabbadini, 2017. "Overcoming the Original Sin: Gains from Local Currency External Debt," Working Papers, Department of Economics 2017_27, University of São Paulo (FEA-USP).
    15. Mark Aguiar & Manuel Amador, 2013. "Sovereign Debt: A Review," NBER Working Papers 19388, National Bureau of Economic Research, Inc.
    16. Hatchondo, Juan Carlos & Martinez, Leonardo & Sosa Padilla, César, 2014. "Voluntary sovereign debt exchanges," Journal of Monetary Economics, Elsevier, vol. 61(C), pages 32-50.
    17. repec:fip:fedreq:y:2012:i:2q:p:139-157:n:vol.98no.2 is not listed on IDEAS
    18. Roettger, Joost, 2019. "Discretionary monetary and fiscal policy with endogenous sovereign risk," Journal of Economic Dynamics and Control, Elsevier, vol. 105(C), pages 44-66.
    19. Ricardo Sabbadini, 2018. "International Reserves Management in a Model of Partial Sovereign Default," Working Papers, Department of Economics 2018_14, University of São Paulo (FEA-USP).
    20. Satyajit Chatterjee & Burcu Eyigungor, 2012. "Maturity, Indebtedness, and Default Risk," American Economic Review, American Economic Association, vol. 102(6), pages 2674-2699, October.
    21. Cohen, Daniel & Villemot, Sébastien, 2012. "The Sovereign Default Puzzle: Modelling Issues and Lessons for Europe," CEPR Discussion Papers 8971, C.E.P.R. Discussion Papers.

    More about this item

    Keywords

    GDP-indexed bonds; sovereign default; risk sharing; state-contingent assets;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:rug:rugwps:22/1056. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Nathalie Verhaeghe (email available below). General contact details of provider: https://edirc.repec.org/data/ferugbe.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.