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An Experimental Analysis of Contingent Capital with Market-Price Triggers

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  • Douglas D. Davis

    ()
    (Department of Economics, VCU School of Business)

  • Korenok Oleg

    ()
    (Department of Economics, VCU School of Business)

  • Edward S. Prescott

    ()
    (Federal Reserve Bank of Richmond)

Abstract

We report an experiment that evaluates three market-based regimes for triggering the conversion of contingent capital bonds into equity: a Òfixed-triggerÓ regime, where a price threshold triggers mandatory conversion, a ÒregulatorÓ regime, where regulators make conversion decisions based on prices and a Òprediction-marketÓ regime, where regulators also observe a market that predicts conversion. Consistent with theory, we observe inefficiencies and conversion errors in the fixed-trigger and regulator regimes. The prediction market somewhat improves the regulatorÕs performance, but inefficiencies and conversion errors persist. The regulator regime has conversion errors over the widest range of shocks.

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File URL: http://www.people.vcu.edu/~okorenok/repec_files/CoCo_Apr30_2013.pdf
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Bibliographic Info

Paper provided by VCU School of Business, Department of Economics in its series Working Papers with number 1102.

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Length: 41 pages
Date of creation: Oct 2011
Date of revision: Apr 2013
Handle: RePEc:vcu:wpaper:1102

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Keywords: bank regulation; experiments; contingent capital;

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References

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  1. Noussair, C.N. & Lei , V. & Plott, C., 2001. "Non-speculative bubbles in experimental asset markets: Lack of common knowledge of rationality vs. actual irrationality," Open Access publications from Tilburg University urn:nbn:nl:ui:12-381105, Tilburg University.
  2. Cason, Timothy N. & Gangadharan, Lata & Duke, Charlotte, 2003. "Market power in tradable emission markets: a laboratory testbed for emission trading in Port Phillip Bay, Victoria," Ecological Economics, Elsevier, vol. 46(3), pages 469-491, October.
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  7. Christian Wolff & Theo Vermaelen & George Pennacchi, 2010. "Contingent Capital: The Case for COERCs," LSF Research Working Paper Series 10-08, Luxembourg School of Finance, University of Luxembourg.
  8. Philip Bond & Itay Goldstein & Edward Simpson Prescott, 2010. "Market-Based Corrective Actions," Review of Financial Studies, Society for Financial Studies, vol. 23(2), pages 781-820, February.
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  10. Admati, Anat R. & DeMarzo, Peter M. & Hellwig, Martin F. & Pfleiderer, Paul, 2010. "Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity Is Not Expensive," Research Papers 2065, Stanford University, Graduate School of Business.
  11. Plott, Charles R. & Salmon, Timothy C., 2004. "The simultaneous, ascending auction: dynamics of price adjustment in experiments and in the UK3G spectrum auction," Journal of Economic Behavior & Organization, Elsevier, vol. 53(3), pages 353-383, March.
  12. John Duffy & Eric O'N. Fisher, 2005. "Sunspots in the Laboratory," American Economic Review, American Economic Association, vol. 95(3), pages 510-529, June.
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  14. repec:reg:wpaper:259 is not listed on IDEAS
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Cited by:
  1. Edward S. Prescott, 2011. "Contingent capital: the trigger problem," Working Paper 11-07, Federal Reserve Bank of Richmond.

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