Pricing GDP-linked bonds

Fernando Eguren-Martin

GDP-linked bonds are sovereign debt instruments with repayments linked to the evolution of a country’s GDP. Originally proposed by Shiller in the 90s, they have recently been re-invoked in the debate around the policy response to the Covid-19 pandemic. These instruments present an obvious attraction for issuers: repayments are lower at times when the economy is growing relatively slowly, which typically coincides with lower tax earnings. A greater share of the risk of weak growth is then transferred to investors, who will require a compensation given they are typically risk-averse. Therefore, while the design is attractive ex-ante, a relevant question facing sovereigns willing to issue this type of instrument is `at what cost?’. In this post (and in an underlying Staff Working Paper) we provide some tentative answers.

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Rational and Behavioural Drivers of Financial Markets: the case of ‘search for yield’

Silvia Pepino.

Rational and behavioural factors can coexist in financial markets. The ‘search for yield’ (or ‘reach for yield’) observed in financial markets in recent years is a striking manifestation of the interaction of rational and behavioural factors. During an extended period of low interest rates and volatility, market participants have displayed a tendency to seek higher returns by investing in securities that carry higher credit, liquidity or duration risk. This tendency to search for yield appears to have been motivated by a mix of rational fundamental considerations, business and regulatory constraints, and behavioural biases.

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