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No-Arbitrage pricing of GDP-Linked bonds

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  • Eguren Martin, Fernando
  • Meldrum, Andrew
  • Yan, Wen

Abstract

We develop a novel term-structure model for pricing GDP-linked bonds, hypothetical securities with cash-flows indexed to the level of U.S. GDP. For this purpose, we rely on a term-structure model of equity yields estimated using the prices of dividend swaps, which we assume span GDP growth. Our approach provides a novel way of estimating the relative cost of conventional and GDP-linked bonds, as well as measuring more general market-based expectations of (and risks around) GDP growth. Our model predicts that U.S. GDP-linked bonds would typically have yields lower than those on conventional Treasury bonds with the same maturity in our sample from 2010 to 2017. Positive expected future GDP growth lowers the yield on GDP-linked bonds relative to conventional bonds, which typically more than offsets the estimated GDP risk premium demanded by investors for holding GDP risk.

Suggested Citation

  • Eguren Martin, Fernando & Meldrum, Andrew & Yan, Wen, 2021. "No-Arbitrage pricing of GDP-Linked bonds," Journal of Banking & Finance, Elsevier, vol. 126(C).
  • Handle: RePEc:eee:jbfina:v:126:y:2021:i:c:s0378426621000339
    DOI: 10.1016/j.jbankfin.2021.106075
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    1. Sarah Mouabbi & Jean-Paul Renne & Jean-Guillaume Sahuc, 2020. "Taming Debt: Can GDP-Linked Bonds Do the Trick?," EconomiX Working Papers 2020-13, University of Paris Nanterre, EconomiX.

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    More about this item

    Keywords

    Affine term structure model (ATSM); Dividend swaps; GDP-Linked bonds; Spanned macroeconomic factors;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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