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Contingent capital: the trigger problem

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  • Edward Simpson Prescott

Abstract

In this article, we analyze price triggers in contingent capital bonds. We illustrate the pervasiveness of multiple equilibria and the nonexistence of equilibrium in theoretical models. We summarize evidence of these problems from market experiments and we evaluate possible solutions.

Suggested Citation

  • Edward Simpson Prescott, 2012. "Contingent capital: the trigger problem," Economic Quarterly, Federal Reserve Bank of Richmond, vol. 98(1Q), pages 33-50.
    • Handle: RePEc:fip:fedreq:y:2012:i:1q:p:33-50:n:v.98no.1
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    References listed on IDEAS

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    1. Edward Simpson Prescott, 2001. "Regulating bank capital structure to control risk," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 35-52.
    2. Calomiris, Charles W. & Herring, Richard J., 2011. "Why and How to Design a Contingent Convetible Debt Requirement," Working Papers 11-41, University of Pennsylvania, Wharton School, Weiss Center.
    3. Charles I. Plosser, 2010. "Convertible Securities and Bankruptcy Reforms: Addressing Too Big to Fail and Reducing the Fragility of the Financial System," Journal of Applied Corporate Finance, Morgan Stanley, vol. 22(3), pages 30-33, June.
    4. Edward Simpson Prescott, 2012. "Contingent capital: the trigger problem," Economic Quarterly, Federal Reserve Bank of Richmond, vol. 98(1Q), pages 33-50.
    5. Marshall, David A. & Prescott, Edward Simpson, 2006. "State-contingent bank regulation with unobserved actions and unobserved characteristics," Journal of Economic Dynamics and Control, Elsevier, vol. 30(11), pages 2015-2049, November.
    6. Flannery, Mark J, 1998. "Using Market Information in Prudential Bank Supervision: A Review of the U.S. Empirical Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(3), pages 273-305, August.
    7. Douglas Davis & Oleg Korenok & Edward Simpson Prescott, 2014. "An Experimental Analysis of Contingent Capital with Market‐Price Triggers," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 46(5), pages 999-1033, August.
    8. Anne Mayhew, 2009. "Institutions," Chapters, in: Jan Peil & Irene van Staveren (ed.), Handbook of Economics and Ethics, chapter 37, Edward Elgar Publishing.
    9. Philip Bond & Itay Goldstein & Edward Simpson Prescott, 2010. "Market-Based Corrective Actions," The Review of Financial Studies, Society for Financial Studies, vol. 23(2), pages 781-820, February.
    10. Marshall, David A. & Prescott, Edward Simpson, 2001. "Bank capital regulation with and without state-contingent penalties," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 54(1), pages 139-184, June.
    11. Charles I. Plosser, 2010. "Convertible securities and bankruptcy reforms: addressing too big to fail and reducing the fragility of the financial system : a speech at the Conference on the Squam Lake Report: Fixing the Financial," Speech 41, Federal Reserve Bank of Philadelphia.
    12. Fama, Eugene F, 1970. "Efficient Capital Markets: A Review of Theory and Empirical Work," Journal of Finance, American Finance Association, vol. 25(2), pages 383-417, May.
    13. Alon Raviv, 2004. "Bank Stability and Market Discipline: Debt-for-Equity Swap versus Subordinated Notes," Finance 0408003, University Library of Munich, Germany.
    14. Douglas Davis & Oleg Korenok & Edward Simpson Prescott, 2011. "An experimental analysis of contingent capital triggering mechanisms," Working Paper 11-01, Federal Reserve Bank of Richmond.
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    1. Douglas Davis & Edward Simpson Prescott, 2017. "Fixed Prices and Regulatory Discretion as Triggers for Contingent Capital Conversion: An Experimental Examination," International Journal of Central Banking, International Journal of Central Banking, vol. 13(2), pages 33-71, June.
    2. Hilscher, Jens & Raviv, Alon, 2014. "Bank stability and market discipline: The effect of contingent capital on risk taking and default probability," Journal of Corporate Finance, Elsevier, vol. 29(C), pages 542-560.
    3. Consiglio, Andrea & Zenios, Stavros A., 2015. "The Case for Contingent Convertible Debt for Sovereignst," Working Papers 15-13, University of Pennsylvania, Wharton School, Weiss Center.
    4. Díaz, Fernando & Ramírez, Gabriel G. & Liu, Liuling, 2018. "Corporate bond clawbacks as contingent capital for banks," Journal of Financial Stability, Elsevier, vol. 37(C), pages 11-24.
    5. Gera Kiewiet & Iman van Lelyveld & Sweder van Wijnbergen, 2017. "Contingent Convertibles: Can the Market Handle them?," Tinbergen Institute Discussion Papers 17-095/VI, Tinbergen Institute.
    6. Edward Simpson Prescott, 2012. "Contingent capital: the trigger problem," Economic Quarterly, Federal Reserve Bank of Richmond, vol. 98(1Q), pages 33-50.
    7. Kenjiro Hori & Jorge Martin Cerón, 2017. "Contingent Convertible Bonds: Payoff Structures and Incentive Effects," Birkbeck Working Papers in Economics and Finance 1711, Birkbeck, Department of Economics, Mathematics & Statistics.
    8. Consiglio Andrea & Zenios Stavros A., 2018. "Contingent Convertible Bonds for Sovereign Debt Risk Management," Journal of Globalization and Development, De Gruyter, vol. 9(1), pages 1-24, June.
    9. Ahrash Dianat & Christoph Siemroth, 2021. "Improving decisions with market information: an experiment on corporate prediction markets," Experimental Economics, Springer;Economic Science Association, vol. 24(1), pages 143-176, March.
    10. Douglas Davis & Oleg Korenok & Edward Simpson Prescott, 2014. "An Experimental Analysis of Contingent Capital with Market‐Price Triggers," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 46(5), pages 999-1033, August.
    11. Fernando Díaz & Gabriel Ramírez & Kenneth Daniels, 2013. "Corporate Bond Clawbacks as Contingent Capital," Working Papers 44, Facultad de Economía y Empresa, Universidad Diego Portales.
    12. Philippe Oster, 2020. "Contingent Convertible bond literature review: making everything and nothing possible?," Journal of Banking Regulation, Palgrave Macmillan, vol. 21(4), pages 343-381, December.
    13. Siemroth, Christoph, 2015. "The impossibility of informationally efficient markets when forecasts are self-defeating," VfS Annual Conference 2015 (Muenster): Economic Development - Theory and Policy 113110, Verein für Socialpolitik / German Economic Association.
    14. Mark J. Flannery, 2016. "Stabilizing Large Financial Institutions with Contingent Capital Certificates," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 6(02), pages 1-26, June.
    15. Michael Sigmund & Kevin Zimmermann, 2021. "Determinants of Contingent Convertible Bond Coupon Rates of Banks: An Empirical Analysis (Michael Sigmund, Kevin Zimmermann)," Working Papers 236, Oesterreichische Nationalbank (Austrian Central Bank).
    16. Gupta, Aparna & Wang, Runzu & Lu, Yueliang, 2021. "Addressing systemic risk using contingent convertible debt – A network analysis," European Journal of Operational Research, Elsevier, vol. 290(1), pages 263-277.
    17. Younghwan Lee & Haerang Park, 2020. "Bank risk‐taking and market discipline: Evidence from CoCo bonds in Korea," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 40(6), pages 885-894, June.
    18. Siemroth, Christoph, 2019. "The informational content of prices when policy makers react to financial markets," Journal of Economic Theory, Elsevier, vol. 179(C), pages 240-274.
    19. Kenjiro Hori & Jorge Martin Ceron, 2016. "Removing Moral Hazard and Agency Costs in Banks: Beyond CoCo Bonds," Birkbeck Working Papers in Economics and Finance 1603, Birkbeck, Department of Economics, Mathematics & Statistics.
    20. George Pennacchi & Alexei Tchistyi, 2018. "Contingent Convertibles with Stock Price Triggers: The Case of Perpetuities," 2018 Meeting Papers 331, Society for Economic Dynamics.
    21. Kenjiro Hori & Jorge Martin Ceron, 2014. "Agency Costs of Bail-in," Birkbeck Working Papers in Economics and Finance 1407, Birkbeck, Department of Economics, Mathematics & Statistics.

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