Reviving the Case for GDP-Indexed Bonds
IMF Policy Discussion Papers, September 1, 2002
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Bibliographic details
- Authors: Eduardo Borensztein, Paolo Mauro
- Published: September 1, 2002
- Series: IMF Policy Discussion Papers
- DOI: https://doi.org/10.5089/9781451970173.003
Overview
- The paper seeks to revive the case for countries to self-insure against economic growth slowdowns by issuing GDP-indexed bonds.
- It uses simulations under different assumptions about fiscal policy reaction functions and their output effects to evaluate the impact of GDP-indexed bonds.
Key findings from the simulations
- GDP-indexed bonds could substantially reduce the likelihood that debt/GDP paths become explosive.
- The insurance premium for GDP-indexed bonds 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.
Analysis of diversification and insurance value
- Low cross-country comovement of GDP growth rates implies substantial diversification benefits for investors holding portfolios of GDP-indexed bonds.
- As a result, the cost of insurance embodied in GDP-indexation is expected to be small.
Fiscal policy interaction and scenarios
- The paper simulates effects under different assumptions about:
- fiscal policy reaction functions, and
- output effects of those fiscal policies.
- Across simulated scenarios, GDP-indexed bonds reduce the probability of explosive debt/GDP dynamics.
Potential obstacles to market emergence
- Verifiability of GDP data.
- Trade-off between insurance and moral hazard.
- Need for liquidity in secondary markets.
Institutional fixes and market start-up approach
- The paper discusses institutional fixes to address the obstacles above.
- It suggests an approach to attempting to start up a market for GDP-indexed bonds.
Subjects and relevant themes
- Bonds; Debt default; Emerging and frontier financial markets; External debt; Financial crises; Financial institutions; Financial markets; Inflation-indexed bonds.
- Keywords include: Africa, Bonds, Debt default, debtor country, Emerging and frontier financial markets, Emerging markets, GDP growth, GDP indexation, GDP ratio, GDP-indexation of bond repayment, GDP-indexed bond, GDP-indexed bonds, Global, Inflation-indexed bonds, PDP, plain vanilla, ratio path.
Reviving the Case for GDP-Indexed Bonds, Eduardo Borensztein and Paolo Mauro, IMF Policy Discussion Paper No. 2002/010.