26 Aprile, 2017 12:30 in punto

Sezione di Finanza Quantitativa

Pricing and Hedging GDP-linked Bonds in Incomplete Markets

Andrea Consiglio, Università di Palermo

Aula Seminari Terzo Piano

An old idea was revived at the G20 leaders meeting in Chengdu, China, in July 2016: issuing contingent debt for sovereigns. The International Monetary Fund was asked to analyze the "technicalities, opportunities, and challenges of state-contingent debt instruments, including GDP-linked bonds" and report back within a year. GDP-linked bonds make debt payments contingent on a country’s GDP. Linking payments to GDP growth rate (or nominal value) ensures that debt can always be serviced. GDP-linked instruments were first suggested during the debt crisis of the 1980’s in the context of debt restructuring. Concerned about a country’s growth prospects in the aftermath of a crisis, creditors and debtor Governments sought instruments for risk sharing to increase debt resilience to macroeconomic shocks. An obstacle in issuing GDP-linked bonds is the need for appropriate pricing models. Furthermore, investors in these novel instruments will need to hedge their risk exposure. Our research addresses these two obstacles by developing a pricing model that, by its nature, provides also a hedging portfolio.