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Experimenting with contingent capital triggers

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  • Edward Simpson Prescott
  • David A. Price

Abstract

Contingent capital is debt that converts to equity when some triggering event occurs. It can automatically recapitalize a bank in distress, thus avoiding potentially costly failure. Unfortunately, little is known empirically about contingent capital regimes because there have been only a few issuances of contingent capital. Results from laboratory experiments suggest that contingent capital with price triggers would increase volatility of prices and the chance of mistakes in conversion decisions.Contingent capital is debt that converts to equity when some triggering event occurs. It can automatically recapitalize a bank in distress, thus avoiding potentially costly failure. Unfortunately, little is known empirically about contingent capital regimes because there have been only a few issuances of contingent capital. Results from laboratory experiments suggest that contingent capital with price triggers would increase volatility of prices and the chance of mistakes in conversion decisions.

Suggested Citation

  • Edward Simpson Prescott & David A. Price, 2012. "Experimenting with contingent capital triggers," Richmond Fed Economic Brief, Federal Reserve Bank of Richmond, issue Feb.
    • Handle: RePEc:fip:fedreb:y:2012:i:feb:n:12-02
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    Keywords

    Financial markets; Financial institutions;

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