NUMERICAL PRICING OF CoCo BONDS WITH PARISIAN TRIGGER FEATURE USING THE FORTET METHOD

Chi Man Leung () and Yue Kuen Kwok
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Chi Man Leung: Department of Mathematics, Hong Kong University of Science and Technology, Hong Kong, P. R. China
Yue Kuen Kwok: Department of Mathematics, Hong Kong University of Science and Technology, Hong Kong, P. R. China

International Journal of Theoretical and Applied Finance (IJTAF), 2017, vol. 20, issue 07, 1-22

Abstract: Unlike conventional convertible bonds, contingent convertible (CoCo) bonds are converted into equity shares of the issuing bank subject to certain trigger mechanisms (accounting and/or regulatory trigger) when the issuing bank is under financial nonviable state. We consider pricing of these CoCo bonds using the contingent claims approach, where the state variables are the stock price and Tier 1 capital ratio. We use the Parisian feature to model the regulatory trigger where equity conversion is triggered when the capital ratio stays under the nonviable state consecutively for a certain period of time. The accounting trigger is modeled using the one-touch barrier feature associated with the capital ratio. The Parisian trigger feature adds one extra path dependent state variable in the pricing model of a CoCo bond. We design effective numerical algorithms for pricing the CoCo bonds using the extended Fortet method that avoid adding one extra state variable for the Parisian feature of regulatory trigger. Pricing properties of the CoCo bonds under both regulatory trigger and accounting trigger are explored.

Keywords: CoCo bonds; conversion triggers; Parisian feature; Fortet method (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (3)

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DOI: 10.1142/S0219024917500467

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