Impact of the introduction of index-linked bonds on a nonindexed bond

In 1982 the British government began to issue bonds indexed to the inflation rate. This article investigates the impact of the introduction of this asset on the market for a nonindexed security. The impact is estimated in the context of a model derived from the literature on interest rate determination and, implicitly, from the consumption technology model. As expected, the introduction of the new asset is found to reduce the price of a pre-existing nonindexed asset, as the introduction of a substitute good should do. Further, changes in the prices of indexed bonds are positively related to the price of the nonindexed security.