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Contingent conversion convertible bond: New avenue to raise bank capital

Author

Listed:
  • Francesca Erica Di Girolamo

    (European Commission, JRC, Via E. Fermi 2749, 21027 Ispra (VA), Italy)

  • Francesca Campolongo

    (European Commission, JRC, Via E. Fermi 2749, 21027 Ispra (VA), Italy)

  • Jan De Spiegeleer

    (#x2020;Department of Mathematics, KU Leuven, Leuven, Belgium‡Head of Risk Management, Jabre Capital Partners, Geneva, Switzerland)

  • Wim Schoutens

    (#x2020;Department of Mathematics, KU Leuven, Leuven, Belgium)

Abstract

This paper provides an in-depth analysis of the structuring and the pricing of an innovative financial market product. This instrument is called a contingent conversion convertible bond or “CoCoCo”. This hybrid bond is itself a combination of two other hybrid instruments: a contingent convertible (“CoCo”) and a convertible bond. This combination introduces more complexity in the structure but it also allows investors to profit from strong share price performances. This upside potential is added on top of the normal contingent convertible mechanics of CoCos, which expose the investors to mainly downside risk. First, we explain how the features of the contingent convertible bonds on one side and the features of the standard convertible bonds on the other side are combined. Thereafter, we propose a pricing approach which moves away from the standard Black&Scholes setting. The CoCoCos are evaluated using the Heston process to which a Hull-White interest rate process has been added. We demonstrate the importance of using a stochastic interest rate when modeling this instrument. Finally we quantify the loss absorbing capacity of this instrument.

Suggested Citation

  • Francesca Erica Di Girolamo & Francesca Campolongo & Jan De Spiegeleer & Wim Schoutens, 2017. "Contingent conversion convertible bond: New avenue to raise bank capital," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 4(01), pages 1-31, March.
    • Handle: RePEc:wsi:ijfexx:v:04:y:2017:i:01:n:s2424786317500013
    DOI: 10.1142/S2424786317500013
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    Cited by:

    1. Wolff, Christian & Masror Khah, Sara Abed, 2015. "The Determinants of CoCo Bond Prices," CEPR Discussion Papers 10996, C.E.P.R. Discussion Papers.
    2. Piotr Jaworski & Kamil Liberadzki & Marcin Liberadzki, 2021. "On Write-Down/ Write-Up Loss Absorbing Instruments," European Research Studies Journal, European Research Studies Journal, vol. 0(1), pages 1204-1219.
    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.

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