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No-arbitrage pricing of GDP-linked bonds

Author

Listed:
  • Fernando Eguren-Martin

    (Bank of England)

  • Andrew Meldrum

    (Federal Reserve Board)

  • Wen Yan

    (Barclays Capital)

Abstract

We use a no-arbitrage term structure model of equity yields computed from the prices of dividend swaps to estimate the yields on hypothetical bonds with cash-flows indexed to the level of US GDP. This provides a novel approach for estimating the possible relative cost of conventional and GDP-linked bonds, which is likely to be of interest to sovereigns considering the case for issuing GDP-linked debt. Our model predicts that US 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. These risk premia decrease with maturity,with unconditional averages falling in absolute value from 7 percentage points at the short-end of the curve to 1 percentage points at the 10-year horizon.

Suggested Citation

  • Fernando Eguren-Martin & Andrew Meldrum & Wen Yan, 2020. "No-arbitrage pricing of GDP-linked bonds," Bank of England working papers 849, Bank of England.
  • Handle: RePEc:boe:boeewp:0849
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    References listed on IDEAS

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    Cited by:

    1. Sarah Mouabbi & Jean-Paul Renne & Jean-Guillaume Sahuc, 2020. "Taming Debt: Can GDP-Linked Bonds Do the Trick?," Working Papers hal-04159700, HAL.
    2. Mouabbi, Sarah & Renne, Jean-Paul & Sahuc, Jean-Guillaume, 2024. "Debt-stabilizing properties of GDP-linked securities: A macro-finance perspective," Journal of Banking & Finance, Elsevier, vol. 162(C).
    3. Emanuele De Meo & Giacomo Tizzanini, 2021. "GDP‐network CoVaR: A tool for assessing growth‐at‐risk," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 50(2), July.
    4. Munch Grønlund, Asger & Jørgensen, Kasper & Schupp, Fabian, 2024. "Measuring market-based core inflation expectations," Working Paper Series 2908, European Central Bank.

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    More about this item

    Keywords

    Affine term structure model (ATSM); bond yield; equity yield; risk premia; dividend swaps; GDP-linke;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G01 - Financial Economics - - General - - - Financial Crises
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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