The Information Content of Indexed Bonds

Abstract

THE INFORMATIVE ROLE OF ASSET MARKETS HAS RECENTLY been emphasized by Barro (1980), Karni (1980), Weiss (1982), Grossman and Weiss (1982), King (1983), and Dotsey and King (1983) in the context of incomplete information, equilibrium business cycle models. An implication of the notion that asset markets are informative is that public finance policy concerning real and nominal debt issuance effects macroeconomic equilibrium through the information content of real and nomlnal bond prices. This paper focuses on inferences about unperceived economic shocks when all agents observe prices in both economy-wide indexed and nominal bond markets. In this framework indexed bond prices help determine perceptions about relative and aggregate disturbances that, in turn, influence the market-clearing value of aggregate output. The analysis of the information content of government-issued indexed bonds is motivated by the following considerations. First, to the extent that incomplete information plays a causal role in business cycles, it is important to examine policies that alter the contemporaneous information available to private agents in making production-employment decisions. While the previous literature, cited above, has made a theoretical case for the proposition that asset markets are informative, as yet there have been few attempts to investigate government finance policies suggested by this proposition. The issuance of real or nominal bonds is perhaps the most dramatic way that government finance policy can affect the information structure of