Convertible Bonds and Bank Risk-Taking

Natalya Martynova and Enrico Perotti

Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: We study how contingent capital affects banks' risk choices. When triggered in highly levered states, going-concern conversion reduces risk-taking incentives, unlike conversion at default by traditional bail-inable debt. Interestingly, contingent capital (CoCo) may be less risky than bail-inable debt as its lower priority is compensated by a lower induced risk. The main benecial effect on risk incentives comes from reduced leverage upon conversion, while any equity dilution has the opposite effect. This is in contrast to traditional convertible debt, since CoCo bondholders have a short option position. As a result, principal writedown CoCo debt is most desirable for risk preventive purposes, although the effect may be tempered by a higher yield. The risk reduction effect of CoCo debt depends critically on the informativeness of the trigger. As it should ensure deleveraging in all states with high risk incentives, it is always inferior to pure equity.

Keywords: Risk shifting; Financial Leverage; Contingent Capital (search for similar items in EconPapers)
JEL-codes: G13 G21 G28 (search for similar items in EconPapers)
Date: 2012-10-09, Revised 2016-10-10
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (18)

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Related works:
Journal Article: Convertible bonds and bank risk-taking (2018)
Working Paper: Convertible bonds and bank risk-taking (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:tin:wpaper:20120106

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