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Worry-Free Inflation-Indexing for Sovereigns - How Governments Can Effectively Deliver Inflation-Indexed Returns to Their Citizens and Retirees

28 Pages Posted: 1 Jun 2011 Last revised: 27 Mar 2012

Zvi Bodie

Boston University - Department of Finance & Economics

Joseph Cherian

NUS Business School

Wee Kang Chua

NUS Business School - Centre for Asset Management Research & Investments

Date Written: May 30, 2011

Abstract

In this paper we explore how small countries such as Malaysia, Singapore, and Taiwan, can offer their aging populations the means to protect their retirement income against inflation without the governments directly issuing inflation-protected bonds. While inflation swaps are a well-known means by which to attain this, we show how an inflation index-replication strategy is also feasible. With this ability to provide inflation-adjusted returns, governments, pension funds, and other institutions can begin to offer a broad suite of inflation-indexed products, ranging from retirement annuities to inflation-linked insurance policies. This will improve the functioning of national pension systems, and hence the welfare of retirees. The added benefit of such structures is that they allow governments to broadly replicate their local Consumer Price Index (CPI) returns without disrupting their traditional financing structures. Given the potential of reinsuring national default risks across borders via currency and credit default swap facilities at the federal level, there is a unique role for the government in this process as the reinsurer of last resort.

Keywords: inflation indexing, inflation-protected bonds, inflation-indexed annuities, pension plans, inflation swaps, inflation index replication

JEL Classification: G11, G15, G18, G23, J26

Suggested Citation

Bodie, Zvi and Cherian, Joseph and Chua, Wee Kang, Worry-Free Inflation-Indexing for Sovereigns - How Governments Can Effectively Deliver Inflation-Indexed Returns to Their Citizens and Retirees (May 30, 2011). Boston U. School of Management Research Paper No. 2011-11. Available at SSRN: https://ssrn.com/abstract=1855824 or http://dx.doi.org/10.2139/ssrn.1855824

Zvi Bodie

Boston University - Department of Finance & Economics ( email )

United States

HOME PAGE: http://www.zvibodie.com

Joseph Cherian

NUS Business School ( email )

Mochtar Riady Building
15 Kent Ridge Drive
Singapore, 119245
Singapore
+65-6516-5991 (Phone)

HOME PAGE: http://bschool.nus.edu/biography#JosephCherian

Wee Kang Chua (Contact Author)

NUS Business School - Centre for Asset Management Research & Investments ( email )

15 Kent Ridge Drive
Level 3-6A, Mochtar Riady Building
Singapore, 119245
Singapore
+65 6516 4160 (Phone)
+65 6778 0390 (Fax)

HOME PAGE: http://www.bschool.nus.edu.sg/CAMRI

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