GDP-linked Bonds: The Case for Greece

Abstract: This thesis examines the benefits and drawbacks of GDP-linked government bonds as a financing tool for the Greek government related to the Greek debt crisis from 2009-2014. Such bonds are characterised by coupon payments which vary in proportion to the GDP growth of the issuing country. Analysing the effect of GDP-linked bonds on the sovereign debt dynamics with a model of endogenous sovereign default, I find evidence that such bonds would have reduced Greece's debt servicing costs, stabilized the Greek debt to GDP ratio as well as lowered the sovereign default probability by up to 19%. The overall magnitude of the benefit of introducing GDP-linked bonds for Greece crucially depends on the GDP risk premium. Although GDP-indexed government bonds alone could not have averted the Greek debt crisis, such debt instruments would have contributed to macroeconomic stabilization by allowing the Greek government to pursue a more countercyclical fiscal policy with interest payments being deferred until the recovery materializes.