Research

Work in progress:

Multiple buffer CoCos and their impact on financial stability 

SSRN

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.

Risk-Taking, Competition and Uncertainty. Do CoCo Bonds Increase the Risk Appetite of Banks?

(joint with Mahmoud Fatouh, Bank of England, and Sweder van Wijnbergen, UvA)

We assess the impact of contingent convertible (CoCo) bonds and the wealth transfers they imply conditional on conversion on risk-taking behaviour of the issuing bank. We also test for regulatory arbitrage: do banks by issuing CoCos try to maintain risk taking incentives when regulators reduce them by insisting on higher capitalization ratios? While we test for and reject sample selection bias, we show that CoCo bonds issuance has a strong positive effect on risk-taking behaviour, and so do conversion parameters that reduce dilution of existing shareholders upon conversion. Higher volatility amplifies the impact of CoCos on risk taking.

Capital Allocation, Leverage Ratio Requirement and Banks’ Risk-Taking

(joint with Quynh- Anh Vo, Bank of England)

[Work in progress]