Managing the risk of relative price changes by splitting index-linked bonds

Andrew R. Aziz, Eliakim Katz, Eliezer Z. Prisman

Abstract

ABSTRACT

In this paper, the authors show that if consumption patterns differ across investors then the "splitting" of a CPI index-linked bond (ILB) into individual components of the CPI offers welfare gains to an economy which are considerably greater than those offered by an ILB that is not split into its components. The welfare gains derived by the splitting of ILBs, over and above the gains derived from the availability of a nonsplit ILB, varies from 5% for low investor levels of risk aversion to 400% and more for higher investor levels of risk aversion.