GDP-linked bonds: a smart financing instrument for few countries

Abstract

In the last years the idea of linking sovereign debt to GDP has gained traction at the academic level, particularly as a mean to stabilize debt levels and allow indebted countries further fiscal space in an environment where teir debt carrying capabilities have been stressed. This thesis sets up the stage for this very idea, then introduces GDP-linked bonds (GLBs), with a focus on the proper design for such a security, matching the need for governments to transfer growth risk to the market to the appetite of investors. The question is then to quantify the benefits of a new mixed debt stock inclusive of both conventional bonds and GLBs. Following the footsteps of already proposed methods in the economic literature to model debt evolution I forecast future debt levels under relatively unrealistic and strict assumptions; by relaxing some of those assumptions I find out that rarely the benefits of indexation overcome its additional costs, raising doubts about their practicality. In spite of how sound the idea of linking debt service to the economy appears and how much it has been endorsed by prominent economists, I argue that the lack of past and current substantial adoption by sovereign states is actually justified.