Contingent Government Liabilities against Private Expectations in England, 1743-49

Christophe Chamley ()
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Christophe Chamley: Department of Economics, Boston University

No dp-166, Boston University - Department of Economics - The Institute for Economic Development Working Papers Series from Boston University - Department of Economics

Abstract: England financed its war of the Austrian succession (1743-48) mainly by issuing 3% bonds and 4% callable bonds which were indeed redeemed by Pelham in 1749 through an interest reduction. Implicit policy rules and constraints made the 4% bond a derivative asset of a 3% perpetual. The price data fit with a model of pricing of this derivative. The estimated model shows that the redemption terms were well anticipated, but government bond prices recovered after the war much sooner than expected. Callable bonds enabled the government to exploit the excess of pessimism during the war and lower its borrowing cost.

Pages: 55 pages
Date: 2007-04
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