## Country Insurance Using Financial Instruments

_IMF Working Papers, July 1, 2011_

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## Bibliographic details
- Authors: Luca A Ricci, Marcos Chamon, Yuanyan S Zhang
- Published: July 1, 2011
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781462315321.001

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### Key findings and analysis
- Financial instruments tied to indices that track global financial conditions and risk appetite can potentially offer countries alternative options to insure against external shocks.
- These instruments can explain much of the in-sample variation in borrowing spreads.
- Hedging strategies based on these instruments fail to perform well out-of-sample during tranquil times.
- Positions on instruments tracking the US High Yield Spread, the VIX, and especially other emerging market CDS spreads can substantially offset adverse movements in a country’s own spreads during times of systemic crises.
- High risk countries appear to gain more from such instruments, as their underlying weaknesses make them more vulnerable to external shocks.
- The limited value of these instruments in tranquil times, together with political economy arguments and innovation costs, could justify the limited interest in this type of hedging in practice.

### Implications for hedging strategies and policy
- Hedging strategies should account for differing performance in tranquil versus systemic-crisis periods:
  - Tranquil times: limited hedging effectiveness out-of-sample.
  - Systemic crises: notable offsetting benefits from positions on US High Yield Spread, VIX, and emerging market CDS indices.
- Countries with higher vulnerability to external shocks (high risk countries) may derive greater insurance value from these instruments.
- Policymakers should weigh:
  - The episodic nature of effectiveness (crisis vs. tranquil periods).
  - Political economy considerations that may limit implementation.
  - Innovation and transaction costs associated with adopting such financial instruments.

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/31/country-insurance-using-financial-instruments-25047_