Quantitative Implications Of Indexed Bonds In Small Open Economies

This paper analyzes the macroeconomic implications of real-indexed bonds, indexed to the terms of trade or GDP, using a general equilibrium model of a small open economy with financial frictions. Although indexed bonds provide a hedge to income fluctuations and can thereby mitigate the effects of financial frictions, they introduce interest rate fluctuations. Because of this tradeoff, there exists a nonmonotonic relation between the "Degree of indexation" (i.e., the percentage of the shock reflected in the return) and the benefits that these bonds introduce.