Multiple buffer CoCos and their impact on financial stability

Ioana Neamtu
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Ioana Neamtu: University of Amsterdam

No 20-010/IV, Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: In this paper we develop a theoretical model to investigate the effect on a bank's financial stability of having multiple contingent convertible bonds buffers (CoCos) on the same bank balance sheet, using cash-in-the-market pricing and global games methodologies. Contingent convertible bonds are meant to act as a bail-in mechanism for banks, where CoCo debt converts into equity when a bank needs it the most. We find that having CoCo buffers which trigger at different capitalisation levels can be detrimental for the CoCo bail-in capacity. Market-based triggers lead to premature conversion and fire-sales of equity. In contrast with existing literature, we show that book-based trigger CoCos yield an optimal outcome, as long as they incorporate expected credit losses.

Keywords: contingent convertible bonds; fire sales; financial stability (search for similar items in EconPapers)
JEL-codes: G21 G32 G38 (search for similar items in EconPapers)
Date: 2020-02-09
New Economics Papers: this item is included in nep-ban
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Persistent link: https://EconPapers.repec.org/RePEc:tin:wpaper:20200010

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