GDP-linked bonds

: design, effects, pricing and way forward

Abstract

GDP-linked bonds could play an important role in helping countries to avoidsolvency crises, defaults and sovereign debt restructurings. Indexing a country’s debtpayments to its economic performance could give governments some type ofinsurance against periods of declining growth rates.In this context, this thesis illustrates the potential advantages of the issuance of suchan instrument, namely by quantifying the above mentioned insurance effect. As such,the interest savings for a group of countries most affected by the European sovereigndebt crisis should they have issued GDP-linked bonds in the beginning of the decadeare calculated. It is concluded that theses savings would have been considerable.Furthermore, in order to understand the additional room for countercyclical fiscalmeasures created by this product, the correlation between primary balance and GDPgrowth is simulated for both scenarios: debt with indexation to GDP growth andwithout it. It is then concluded that correlation between those two variables would besignificantly higher with indexation.In the same vein, it is also simulated the issuance of this instrument in currencyunions, in particular in the euro area, applying the corresponding fiscal constraint tothe total deficit of 3% of GDP. Thus, the correlation between primary balance andGDP growth shows that indexing debt to GDP growth has the potential to offset thecurbing effect of the mentioned constraint.Moreover, through simple regressions and using the Capital Asset Pricing Model, itis concluded that the portion of undiversified risk associated to the indexation toGDP growth would be low.

Date of Award	26 Jul 2017
Original language	English
Awarding Institution	Universidade Católica Portuguesa
Supervisor	Diana Bonfim (Supervisor)