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Fighting Fire with Gasoline: CoCos in Lieu of Equity

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  • ROMAN GONCHARENKO

Abstract

In this paper, I theoretically examine the ability of contingent convertible bonds (CoCos), a source of bank capital under Basel III, to reduce the bank's default risk. Although issuing CoCos adds a buffer to the bank's balance sheet, it may induce wrong incentives in the form of debt overhang and risk shifting. My results indicate that the most popular type of CoCos, temporary write‐down (TWD), is least effective at mitigating default risk. Unlike other types of CoCos, TWDs continue affecting shareholders' incentives even after the trigger event, thereby inducing an earlier endogenous default.

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  • Roman Goncharenko, 2022. "Fighting Fire with Gasoline: CoCos in Lieu of Equity," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 54(2-3), pages 493-517, March.
    • Handle: RePEc:wly:jmoncb:v:54:y:2022:i:2-3:p:493-517
    DOI: 10.1111/jmcb.12857
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    Cited by:

    1. Goncharenko, Roman & Ongena, Steven & Rauf, Asad, 2021. "The agency of CoCos: Why contingent convertible bonds are not for everyone," Journal of Financial Intermediation, Elsevier, vol. 48(C).
    2. Giovanni Calice & Carlo Sala & Daniele Tantari, 2020. "Contingent Convertible Bonds in Financial Networks," Papers 2009.00062, arXiv.org, revised Dec 2023.
    3. 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.
    4. Goncharenko, Roman & Ongena, Steven & Rauf, Asad, 2017. "The agency of CoCo: Why do banks issue contingent convertible bonds?," CFS Working Paper Series 586, Center for Financial Studies (CFS).

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