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This paper seeks to revive the case for countries to self-insure against economic growth slowdowns by issuing GDP-indexed bonds. We simulate the effects of GDP-indexed bonds under different assumptions about fiscal policy reaction functions and their output effects and find that they could substantially reduce the likelihood that debt/GDP paths become explosive. The insurance premium would likely be small, because cross-country comovement of GDP growth rates is low and cross-country GDP growth risk is thus largely diversifiable for an investor holding a portfolio of GDP-indexed bonds. Potential obstacles to the emergence of a market for these bonds include the verifiability of GDP data, the trade-off between insurance and moral hazard, and the need for liquidity. The paper discusses institutional fixes and suggests an approach to attempting to start up a market.
Exports and Imports --- Finance: General --- Financial Risk Management --- Investments: Bonds --- International Monetary Arrangements and Institutions --- International Lending and Debt Problems --- Financial Aspects of Economic Integration --- Contingent Pricing --- Futures Pricing --- option pricing --- International Financial Markets --- General Financial Markets: General (includes Measurement and Data) --- Financial Crises --- Investment & securities --- Finance --- Economic & financial crises & disasters --- International economics --- Bonds --- Inflation-indexed bonds --- Emerging and frontier financial markets --- Financial crises --- Debt default --- Financial institutions --- Financial markets --- External debt --- Financial services industry --- Debts, External --- United States
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