Coco Design, Risk Shifting Incentives and Capital Regulation
Stephanie Chan and
Sweder van Wijnbergen ()
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Stephanie Chan: University of Amsterdam, the Netherlands
No 16-007/VI, Tinbergen Institute Discussion Papers from Tinbergen Institute
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)
New Economics Papers: this item is included in nep-ban, nep-cfn, nep-rmg and nep-upt
Date: 2016-02-01, Revised 2017-11-13
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Persistent link: https://EconPapers.repec.org/RePEc:tin:wpaper:20160007
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