Research

Work in progress:

Multiple buffer CoCos and their impact on financial stability 

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, BoE, and Sweder van Wijnbergen, UvA)

This paper inspects the interaction between risk-taking behaviour of banks, contingent convertible bonds, banking competition and macroeconomic uncertainty in the United Kingdom. We assess the effect of CoCo bonds on risk-taking based on the expected size of dilution of existing shareholders wealth, and we find that lower expected dilution increases a banks’ risk profile. CoCo issuance has a strong positive effect on risk-taking behaviour. We test the regulatory arbitrage hypothesis in the CoCo setting, in which we argue that banks issue specific types of CoCo bonds (dilutive/non-dilutive) which will allow them to either maintain or increase their risk profile against regulatory attempts to reduce it. Our results indicate that CoCo bond issuing banks tend to take on less asset risk if they face higher levels of macroeconomic uncertainty.

[Early draft available on request]

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

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

[Work in progress]