Working Paper: CEPR ID: DP16795
Authors: Deniz Igan; Taehoon Kim; Antoine Levy
Abstract: State-contingent debt instruments such as GDP-linked warrants have garnered attention as a potential tool to help debt-stressed economies smooth repayments over business cycles, yet very few studies of the empirical properties of these instruments exist. This paper develops a general framework to estimate the time-varying risk premium of a state-contingent sovereign debt instrument. Our estimation framework applied to GDP-linked warrants issued by Argentina, Greece, and Ukraine reveals three stylized facts: (i) the risk premium in state-contingentinstruments is high and persistent; (ii) the risk premium exhibits a pro-cyclical pattern; and (iii) the liquidity premium is higher and more volatile than that for plain-vanilla government bonds issued by the same sovereign. We then present a model in which investors fear ambiguity and that can account for the cyclical properties of the risk premium.
Keywords: State-contingent debt instruments; GDP-linked warrants; Risk premia; Procyclicality
JEL Codes: H63; G13; E44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| SCDi premium (G52) | high and persistent (E39) |
| SCDi premium (G52) | fluctuates widely over business cycles (E32) |
| SCDi premium (G52) | procyclical pattern (E32) |
| default premium (G22) | rises during downturns (E32) |
| liquidity premium for GDP-linked warrants (G19) | higher and more volatile than plain-vanilla government bonds (G19) |