Coco Design, Risk Shifting Incentives and Capital Regulation

Stephanie Chan and Sweder van Wijnbergen
Additional contact information
Stephanie Chan: University of Amsterdam, the Netherlands

No 16-007/VI, Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: Contingent convertible capital (CoCo) is a debt instrument that converts to equity or is written off if the issuing bank fails to meet a distress threshold. The conversion increases the issuer's loss-absorption capacity, but results in wealth transfers between CoCo holders and shareholders, which may change risk-shifting incentives to shareholders. Higher risk increases the probability of CoCo conversion, while lowering the wealth transfer. We show that for Principal-Write-Down (PWD) CoCos, the net effect is to always increase risk-shifting incentives, while for equity-converting CoCos, it depends on the extent of dilution after conversion. We integrate the analysis in a game-theoretic optimal capital regulation framework and show that use of PWD or insuffciently dilutive CE CoCos requires higher capital requirements for given asset structure to offset the rising risk-shifting incentives these instruments give rise to.

Keywords: Contingent Convertible Capital; Systemic Risk; Risk Shifting Incentives; Capital Requirements (search for similar items in EconPapers)
JEL-codes: G01 G13 G21 G28 G32 (search for similar items in EconPapers)
Date: 2016-02-01, Revised 2017-11-13
New Economics Papers: this item is included in nep-ban, nep-cfn, nep-rmg and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (14)

Downloads: (external link)
https://papers.tinbergen.nl/16007.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:tin:wpaper:20160007

Access Statistics for this paper

More papers in Tinbergen Institute Discussion Papers from Tinbergen Institute Contact information at EDIRC.
Bibliographic data for series maintained by Tinbergen Office +31 (0)10-4088900 ().