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Contingent Convertibles with Stock Price Triggers: The Case of Perpetuities

George Pennacchi and Alexei Tchistyi
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George Pennacchi: University of Illinois
Alexei Tchistyi: University of Illinois

No 331, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: Initial proposals for bank contingent convertibles (CoCos) envisioned that these bonds would convert to equity when the bank's stock price declined to a pre-specifi ed trigger. Subsequent research claimed that doing so causes the stock price to have multiple equilibria or no equilibrium. We show that when CoCos are perpetuities, which characterizes most actual CoCos, a unique stock price equilibrium exists except under unrealistic conditions. Unique equilibria occur when conversion favors or disfavors CoCo investors, when CoCos convert to equity or are written down, and when CoCos are callable. We also analyze a banks choice of risk before and after conversion.

Date: 2018
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