tailieunhanh - Are Indexed Bonds a Remedy for Sudden Stops?¤ Ceyhun Bora Durdu

The concept of common issuance was first discussed by Member States in the late 1990s, when the Giovannini Group (which has advised the Commission on capital-market developments related to the euro) published a report presenting a range of possible options for co-ordinating the issuance of euro-area sovereign debt 3 . In September 2008, interest in common issuance was revived among market participants, when the European Primary Dealers Association (EPDA) published a discussion paper "A Common European Government Bond" 4 . This paper confirmed that euro-area government bond markets remained highly fragmented almost 10 years after the introduction of the euro and discussed the. | Are Indexed Bonds a Remedy for Sudden Stops Ceyhun Bora Durdu University of Maryland December 2005 Abstract Recent policy proposals call for setting up a benchmark indexed bond market to prevent Sudden Stops. This paper analyzes the macroeconomic implications of these bonds using a general equilibrium model of a small open economy with financial frictions. In the absence of indexed bonds negative shocks to productivity or to the terms of trade trigger Sudden Stops through a debt-deflation mechanism. This paper establishes that whether indexed bonds can help to prevent Sudden Stops depends on the degree of indexation or the percentage of the shock reflected in the return. Quantitative analysis calibrated to a typical emerging economy suggests that indexation can improve macroeconomic conditions only if the level of indexation is less than a critical value due to the imperfect nature of the hedge provided by these bonds. When indexation is higher than this critical value as with fullindexation natural debt limits become tighter leading to higher precautionary savings. The increase in the volatility of the trade balance that accompanies the introduction of indexed bonds outweighs the improvement in the covariance of the trade balance with income increasing consumption volatility. Additionally we find that at high levels of indexation the borrowing constraint can become suddenly binding following a positive shock triggering a debt-deflation. JEL Classification F41 F32 E44 Keywords Indexed Bonds Degree of Indexation Financial Frictions Sudden Stops I am greatly indebted to Enrique Mendoza Guillermo Calvo Boragan Aruoba and John Rust for their suggestions and advice. I would like to thank David Bowman Emine Boz Christian Daude Jon Faust Dale Henderson Ayhan Kose Marcelo Oviedo John Rogers Harald Uhlig Carlos Vegh Mark Wright the participants of the International Finance seminar at the Federal Reserve Board the International Development Workshop at the University of .