Designing GDP-Linked Bonds with Default

We develop and present a model for pricing GDP-linked bonds that takes into account both GDP fluctuations and fiscal default. The indexation is based on the size of GDP deviations from the trend and default is based on the size of sovereign debt. We consider a mapping of these instruments to normal...

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Bibliographic Details
Published inApplied economics quarterly Vol. 67; no. 4; pp. 311 - 335
Main Authors Leventides, John, Melas, Evangelos, Poulios, Costas, Boufounou, Paraskevi, Leventides, Rena Artemis
Format Journal Article
LanguageEnglish
German
Published Berlin Duncker & Humblot Gmbh 01.10.2021
Subjects
Central banks
Debt management
Debt restructuring
Default
Economic crisis
Economic development
Economic growth
GDP
Gross Domestic Product
International finance
Mapping
Recessions
Sovereign debt
Sustainability
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Summary:We develop and present a model for pricing GDP-linked bonds that takes into account both GDP fluctuations and fiscal default. The indexation is based on the size of GDP deviations from the trend and default is based on the size of sovereign debt. We consider a mapping of these instruments to normal fixed-income securities, and a bond equivalent yield is calculated as well as a default premium. We construct various indexed bond products with different coupon variations and we price them via Monte-Carlo simulations for the case of Greece. The model can be applied to other countries provided that the data are adjusted. One of the main results is that GDP-linked bonds are more conducive to debt management. In particular, replacing conventional bond instruments with carefully designed GDP-linked bonds of equivalent yield can lead to lower terminal values of debt-to-GDP ratio, provided that the macroeconomic environment is the same.
ISSN:1611-6607
1865-5122
DOI:10.3790/aeq.67.4.311