Pricing GDP Linked Securities
44 Pages Posted: 8 Apr 2014
Date Written: April 7, 2014
We propose a simple model for the valuation of sovereign growth linked bonds. The model is calibrated to potential GDP, output gap, real exchange rate and rating implied historical default probabilities. Bond prices are obtained by applying the Esscher transform on the simulated cash flows with the risk aversion parameter calibrated to match market prices of vanilla bonds of the sovereign (or a comparable sovereign). The model was applied to Argentinian data and its US$ vanilla bonds before being used to price Argentina's GDP warrants. Results indicate that our model produce valuations that are close to observed market prices.
Keywords: GDP linked bond, Incomplete Markets, Structural Models, Esscher transform, General Equilibrium
JEL Classification: D52, G13, C22
Suggested Citation: Suggested Citation