No-Arbitrage pricing of GDP-Linked bonds

Fernando Eguren Martin, Andrew Meldrum and Wen Yan

Journal of Banking & Finance, 2021, vol. 126, issue C

Abstract: We develop a novel term-structure model for pricing GDP-linked bonds, hypothetical securities with cash-flows indexed to the level of U.S. GDP. For this purpose, we rely on a term-structure model of equity yields estimated using the prices of dividend swaps, which we assume span GDP growth. Our approach provides a novel way of estimating the relative cost of conventional and GDP-linked bonds, as well as measuring more general market-based expectations of (and risks around) GDP growth. Our model predicts that U.S. GDP-linked bonds would typically have yields lower than those on conventional Treasury bonds with the same maturity in our sample from 2010 to 2017. Positive expected future GDP growth lowers the yield on GDP-linked bonds relative to conventional bonds, which typically more than offsets the estimated GDP risk premium demanded by investors for holding GDP risk.

Keywords: Affine term structure model (ATSM); Dividend swaps; GDP-Linked bonds; Spanned macroeconomic factors (search for similar items in EconPapers)
JEL-codes: E43 G1 H63 (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (2)

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Working Paper: No-arbitrage pricing of GDP-linked bonds (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:126:y:2021:i:c:s0378426621000339

DOI: 10.1016/j.jbankfin.2021.106075

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