DP16795 The Premia on State-Contingent Sovereign Debt Instruments
|Author(s):||Deniz Igan, Taehoon Kim, Antoine Levy|
|Publication Date:||December 2021|
|Keyword(s):||GDP-linked warrants, procyclicality, risk premia, State-contingent debt instruments|
|JEL(s):||E44, G13, H63|
|Programme Areas:||Financial Economics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=16795|
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-contingent instruments 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.