The Welfare Gain from the Introduction of Indexed Bonds

Indexed Bonds and Heterogeneous Agents

“…Using a CAPM framework and data on the yields of securities with different inflation risks, Kantor (1986) and Bodie et al (1986) argue that the market already provides an efficient inflation hedge without indexed securities. Viard (1993) also reaches this conclusion in a theoretical model based on restrictive assumptions, such as homogeneous expectations of inflation. (Viard's model is more applicable to indexed securities issued by private agents than to indexed government securities.…”

Inflation‐Indexed Bonds and Nominal Bonds: Financial Innovation and Precautionary Motives

“…The model in this paper is closely related to earlier theoretical works on nominal versus indexed bonds by Fischer () and Viard (). Fischer () initially investigated the consumers' demand for the indexed bond based on relative risk aversion and inflation volatility.…”

“…This result implies that using mean‐variance preferences, where agents lack precautionary savings motives, overestimates the borrowers' welfare gains but underestimates the savers' gains by financial innovation on indexed bonds. More importantly, as mean‐variance utility functions minimize the impact of financial innovation on existing asset prices, Pareto improvement with the introduction of an indexed bond is guaranteed, as shown in Viard (), Magill and Quinzii (), and Geanakoplos ().…”

“…This paper extends Fischer's () result by showing that incorporating transaction costs allows the indexed and nominal bond markets to coexist. Viard () showed that saver and borrower's welfare gain from the indexed bond is proportional to the variance of the minimum‐variance portfolio and is positively related to the divergence of their relative risk aversion from that of the market. Even though Viard () used the CRRA utility functions in which consumers have precautionary saving motives, he used the Taylor approximation in a way that the third derivative of the utility is ignored.…”

The behavior of government of Canada real return bond returns

“…3 Magill and Quinzii (1997) explain theoretically why it takes high inflation variability before private sector agents switch to indexed contracts and use this to explain why indexed debt is more common in Latin America than in western economies. Viard (1993) has argued that investors with a high degree of risk aversion should want to hold positive amounts of index-linked bonds in their portfolios. Taylor (2000) examined what proportion of portfolios of investors would have been invested in indexed bonds between 1927 and 1996 if they had been part of the available asset set during those years.…”