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Mind the conversion risk: contingent convertible bonds as a transmission channel of systemic risk

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  • Gaëtan Le Quang

Abstract

We develop a model to assess the systemic risk associated with contingent convertible (coco) bonds. When their conversion is related to changes in their market price ? in the perspective of what the literature has coined as indirect market discipline ?, coco bonds can act as a transmission channel of systemic risk. In this case, a self-fulfilling crisis can indeed occur because of panic sales of coco bonds motivated by the expectation of conversion by coco bonds? holders. In addition, we show that increasing the precision of the information disclosed by the bank through its financial statements most of the times decreases the probability that such a crisis happens. On the contrary, increasing the precision of the information privately held by coco bonds? holders has most of the times the opposite effect. This paper therefore calls for cautiousness when it comes to considering market-triggered coco bonds as a complement to equity. JEL codes: G21, G28, G33, K23

Suggested Citation

  • Gaëtan Le Quang, 2024. "Mind the conversion risk: contingent convertible bonds as a transmission channel of systemic risk," Finance, Presses universitaires de Grenoble, vol. 45(1), pages 114-145.
    • Handle: RePEc:cai:finpug:fina_pr_019
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    More about this item

    Keywords

    banking regulation; capital requirements; bail-in; contingent convertible bonds; market discipline;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • K23 - Law and Economics - - Regulation and Business Law - - - Regulated Industries and Administrative Law

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