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An experimental analysis of contingent capital triggering mechanisms

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  • Douglas Davis
  • Edward S. Prescott
  • Oleg Korenok

Abstract

This paper reports an experiment that evaluates three regimes for triggering the conversion of contingent capital bonds into equity: (a) a “regulator” regime, where socially motivated regulators make conversion decisions based on observed prices, (b) a “fixed trigger” regime where a price threshold triggers a mandatory conversion, and (c) a “prediction market” regime where we supplement the regulator’s information set with the results of a prediction market that elicits traders’ perceived likelihood of a conversion. Consistent with theory, we observe informational and allocative inefficiencies as well as numerous errors in conversion decisions in both the regulator and fixed trigger regimes. Contrary to theory, however, we also observe inefficiencies and frequent conversion errors in the prediction market regime. Although the fixed trigger and prediction market regimes are more informationally efficient than the regulator regime, allocative efficiencies remain low and conversion error rates high in all three regimes. ; Earlier title: Market-based corrective actions - an experimental investigation

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Bibliographic Info

Paper provided by Federal Reserve Bank of Richmond in its series Working Paper with number 11-01.

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Date of creation: 2011
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Handle: RePEc:fip:fedrwp:11-01

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Related research

Keywords: Financial institutions ; Financial markets;

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References

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Cited by:
  1. repec:fip:fedreq:y:2012:i:1q:p:33-50:n:vol.98no.1 is not listed on IDEAS
  2. Edward S. Prescott, 2011. "Contingent capital: the trigger problem," Working Paper 11-07, Federal Reserve Bank of Richmond.

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