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An experimental analysis of contingent capital triggering mechanisms

Douglas Davis (), Edward Prescott () and Oleg Korenok ()

No 11-01, Working Paper from Federal Reserve Bank of Richmond

Abstract: This paper reports an experiment that evaluates three regimes for triggering the conversion of contingent capital bonds into equity: (a) a “regulator” regime, where socially motivated regulators make conversion decisions based on observed prices, (b) a “fixed trigger” regime where a price threshold triggers a mandatory conversion, and (c) a “prediction market” regime where we supplement the regulator’s information set with the results of a prediction market that elicits traders’ perceived likelihood of a conversion. Consistent with theory, we observe informational and allocative inefficiencies as well as numerous errors in conversion decisions in both the regulator and fixed trigger regimes. Contrary to theory, however, we also observe inefficiencies and frequent conversion errors in the prediction market regime. Although the fixed trigger and prediction market regimes are more informationally efficient than the regulator regime, allocative efficiencies remain low and conversion error rates high in all three regimes. ; Earlier title: Market-based corrective actions - an experimental investigation

Keywords: Financial institutions; Financial markets (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban and nep-exp
Date: 2011
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