What’s the contingency? A proposal for bank contingent capital triggered by systemic risk

Linda Allen and Yi Tang

Journal of Financial Stability, 2016, vol. 26, issue C, 1-14

Abstract: Contingent capital (coco) automatically recapitalizes the banking system during financial crises if the trigger mechanism is properly designed. We propose a dual trigger mechanism based on: (1) aggregate systemic risk in the banking system, measured using CATFIN, and (2) the individual bank’s contribution to overall systemic risk, measured using delta CoVaR. The dual trigger is highly correlated with system-wide insolvency risk and prices systemic risk. We set different triggers for banks, insurance companies and broker-dealers. Using the 99% cut-off, systemic coco issued by Lehman and Bear Stearns would have been triggered in November 2007, months prior to their actual demise.

Keywords: Contingent capital; Callable put option; Dual trigger exercise price; Systemic risk (search for similar items in EconPapers)
JEL-codes: E58 G21 (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (10)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finsta:v:26:y:2016:i:c:p:1-14

DOI: 10.1016/j.jfs.2016.06.005

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