Marginal Revolution: GDP-Linked Securities

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GDP-Linked Securities

Referring to my post on drought insurance and the coming new financial order, Daniel Strauss Vasques alerts me to the fact that Argentina has recently issued some GDP-linked securities.

The payout to the Argentinian securities is complex it occurs only if Actual GDP exceeds "Base-Case GDP" and the growth rate of Actual GDP exceeds the growth rate of Base Case GDP. Base-Case GDP is just a particular projection of GDP which is fixed in advance. If these conditions are met then 5% of the difference between Actual and Base-Case GDP, called Excess GDP, is paid to the security holders in proportion to their holdings. Total payments are also subject to a cap. (Here is a very long PDF prospectus if you want further information).

The Argentinian securities are a good beginning but they are unnecessarily complex. It would be much better to establish a market in which anyone could buy or sell a simple security based on GDP, e.g. every unit of a US GDP Share would pay out 1 trillionth of US GDP.

Aside from allowing greater national and international risk-bearing, GDP Shares defined in this simple way would be very useful for decision markets. If GDP Shares started to decline as the prospects for a Democrat/Republican victory increased, for example, we would have ample grounds for rethinking our decision. Ultimately, we might use these markets to replace politics.

Comments are open.

Posted by Alex Tabarrok on March 10, 2006 at 07:14 AM in Economics | Permalink

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Comments

One of the more bizarre programs in a long time. Would these not be
hostage to the decidedly non-GAAP standards of GDP accounting as well as to
the whims of economists and bureaucrats in making new definitions
of accounting categories?

Posted by: Bill Stepp at Mar 10, 2006 7:47:03 AM

For quality-of-statistics junkies, from page S-33 of the prospectus:

Furthermore, any alteration in the calculation or compilation of Argentina's gross domestic product by INDEC, the institution responsible for compiling Argentina's economic statistics, which is controlled by the Argentine government, may result in a decrease in value of or return on the GDP-linked Securities. Argentina will not be required to make an adjustment to the amounts previously paid to holders of the GDP-linked Securities for changes that may affect the calculation of Argentina's gross domestic product. [Emphasis added]

This also presents an incentive to stop adding more quality-adjustment factors to price index statistics. Quality adjustment tends to lower calculated inflation rates and raise real growth rates. I gather that rebenchmarking would affect "Actual GDP" levels, but "base GDP" would be unaffected.

What other incentives do government agencies have to publish lower-than-actual real GDP level or growth figures?

Posted by: Kevin Brancato at Mar 10, 2006 8:53:02 AM

Alex,

I realize I suggested only yesterday that these would be a good way to replace Congressional compensation. I think it would. However, I think we're still a long way from convincing a large percentage of the population that (1) financial incentives work & are a good thing, and (2) GDP growth is an inherant good.

Posted by: Brock at Mar 10, 2006 9:41:58 AM

This sounds like a good idea... There are two risks that need to be managed. First, the definition of GDP may be politicized. Could there be potentially significant manipulations? Shifting of production statistics from one period to another? Maybe.

Another risk would be political... If prosperity is clerly linked to higher interest payments, then the enemies of progress will have more ammunition. A government that returns 6% GDP growth will pay out a lot more than a government in recession... So the pro-growth politicians will seem to be lapdogs of the rich bankers who stand to profit. (In perception, anyway.)

GDP definitions need to be very clearly spelled out in an immutable and apolitical way. Data sources will need to be watched closely by some agent we can trust... I dunno who.

Posted by: Stephen W. Stanton at Mar 10, 2006 9:43:20 AM

Not exactly a new idea:

"The Bank of San Giorgio issued, on behalf of the Republic of Genoa, placements of perpetual bonds, called luoghi, at a nominal value of 100 lira each. Their income was secured by specific taxes farmed out to the bank. The luoghi did not pay a fixed rate of interest [...] but paid dividends which depended on the amount of taxes collected after payment of the expenses of the bank," write Sidney Homer and Richard Sylla in their book, A History of Interest Rates.

http://www.tcsdaily.com/article.aspx?id=072005A

Posted by: Pavel Kohout at Mar 10, 2006 10:58:22 AM

Let me make sure I understand this.

Step 1. Give money to a government that only five years ago staged the biggest default in history.

Step 2. Have that government use a bureacracy not renknowned for its efficiency, transparency, or resistance to corruption to compile economice data

Step 3. Wait for said government to mail me a big check based on numbers from said bureacracy,even though said government is so whimsical in its foreigner commitments to that just this week is banned beef exports because "We are not interested in exporting at the expense of the hunger of the people"

Great! Where do I sign up?

Posted by: tylerh at Mar 10, 2006 3:23:30 PM

This contract and prospectus has a terrible design. Additionally, the idea of GDP shares is useless too
how do you get access to an underlying for hedging purposes? Unless they are issued by a government,
they aren't all that great. And there are serious issues of providing equity in the capital structure
of a country.

The best way to do this is to have an exchange for GDP futures much like interest rate futures and swaps
and then be able to build up a swap curve. Then you can issue structured notes or products that can be
bought by people with a view, or used as a macro hedge for various businesses much like commodity markets.

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