The chilean experience in completing markets with financial indexation
For a Chilean capital market participant, it may be hard to imagine a world without the indexation unit, the Unidad de Fomento (UF). Most market participants would probably agree that the UF played a central role in the creation of a local capital market and also that it has had a positive impact on growth and welfare. The trouble, of course, is proving it, which is precisely what this paper aims to do. From an investor’s perspective, financial indexation may have quite a different role than the one presumably assigned to it by economic authorities. For the latter, indexation may represent an efficient mechanism for signaling to the market a commitment to keeping inflation under control. This, in turn, has to be weighed against the possibility of smoothing taxes by letting inflation dilute the value of the outstanding nominal government debt, although this creates certain time inconsistencies. 1 From this perspective, then, completing the financial market is not directly relevant, even though it may be important for determining the financial costs of government debt. The optimal government debt structure could take into account its implications on welfare, efficiency, and the completeness of the financial markets.