Indexed Sovereign Debt: An Applied Framework

A number of countries have issued sovereign debt instruments indexed to real variables in recent years. This type of contracts could improve risk sharing between debtor countries and international creditors and diminish the probability of occurrence of debt crises. This paper characterizes the optimal features of real indexed sovereign debt contracts in a dynamic stochastic equilibrium framework with incomplete markets. We show that the optimal indexed debt contract should not be studied abstracting from the total portfolio of assets and liabilities of the issuing country. We also show that the optimal contract is similar to an insurance contract, and that a country can replicate it using existing instruments, in particular, a combination of international reserves and GDP-indexed bonds. Calibrating our model to Argentina's economy we find that the welfare gains from introducing indexed debt and allowing asset accumulation could be equivalent to an increase of between 0.1% and 0.5% in certainty equivalent aggregate consumption.