Debt-Stabilizing Properties of GDP-Linked Securities: A Macro-Finance Perspective

Abstract

We study the debt-stabilizing properties of indexing debt to GDP using a consumption-based macro-finance model. To this end, we derive quasi-analytical pricing formulas for any type of bond or equity by exploiting the discretization of the state-space, which makes large-scale simulations tractable. Such pricing formulas are feasible thanks to an approximation of the risk-neutral dynamics—a novelty in this class of models. Three results stand out. First, GDP-linked security prices would embed sizable and time-varying risk premiums of about 40 basis points. Second, for a fixed budget surplus, issuing GDP- linked securities does not necessarily imply more beneficial debt-to-GDP ratios in the medium- to long-run. Third, the debt-stabilizing budget surplus is more predictable under such issuances at the expense of being higher on average. Our findings call into question the view that GDP-linked securities tame debt.

Keywords: GDP-linked securities, term structure, consumption-based model, debt stabilization

JEL Classification: E43, G12, G18, H63.