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Financial Instruments to Hedge Commodity Price Risk for Developing Countries

  • Yinqiu Lu
  • Salih N. Neftci

Many developing economies are heavily exposed to commodity markets, leaving them vulnerable to the vagaries of international commodity prices. This paper examines the use of commodity options-including plain vanilla, risk reversal, and barrier options-to hedge such risk. It then proposes the use of a new structured product-a sovereign Eurobond with an embedded option on a specific commodity price. By extracting commodity price risk out of the bond, such an instrument insulates the bond default risk from commodity price movements, allowing it to be marketed at a lower credit spread. The product is also designed to help developing countries establish a credit derivatives market, which would in turn enhance the marketability and liquidity of sovereign bonds.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 08/6.

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Length: 20
Date of creation: 01 Jan 2008
Date of revision:
Handle: RePEc:imf:imfwpa:08/6
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  1. 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.
  2. repec:rus:hseeco:74540 is not listed on IDEAS
  3. Joseph Atta-Mensah, 2004. "Commodity-Linked Bonds: A Potential Means for Less-Developed Countries to Raise Foreign Capital," Working Papers 04-20, Bank of Canada.
  4. Paolo Mauro & Törbjörn I. Becker & Jonathan David Ostry & Romain Ranciere & Olivier Jeanne, 2007. "Country Insurance; The Role of Domestic Policies," IMF Occasional Papers 254, International Monetary Fund.
  5. Larson, Donald F. & Varangis, Panos & Yabuki, Nanae, 1998. "Commodity risk management and development," Policy Research Working Paper Series 1963, The World Bank.
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