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CoCo Bonds Valuation with Equity- and Credit-Calibrated First Passage Structural Models

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Listed:
  • Damiano Brigo
  • Jo~ao Garcia
  • Nicola Pede

Abstract

After the beginning of the credit and liquidity crisis, financial institutions have been considering creating a convertible-bond type contract focusing on Capital. Under the terms of this contract, a bond is converted into equity if the authorities deem the institution to be under-capitalized. This paper discusses this Contingent Capital (or Coco) bond instrument and presents a pricing methodology based on firm value models. The model is calibrated to readily available market data. A stress test of model parameters is illustrated to account for potential model risk. Finally, a brief overview of how the instrument performs is presented.

Suggested Citation

  • Damiano Brigo & Jo~ao Garcia & Nicola Pede, 2013. "CoCo Bonds Valuation with Equity- and Credit-Calibrated First Passage Structural Models," Papers 1302.6629, arXiv.org.
  • Handle: RePEc:arx:papers:1302.6629
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    File URL: http://arxiv.org/pdf/1302.6629
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    References listed on IDEAS

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    1. Damiano Brigo & Marco Tarenghi, 2009. "Credit Default Swap Calibration and Equity Swap Valuation under Counterparty Risk with a Tractable Structural Model," Papers 0912.3028, arXiv.org.
    2. Goldstein, Robert & Ju, Nengjiu & Leland, Hayne, 2001. "An EBIT-Based Model of Dynamic Capital Structure," The Journal of Business, University of Chicago Press, vol. 74(4), pages 483-512, October.
    3. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    4. Damiano Brigo & Massimo Morini & Marco Tarenghi, 2009. "Credit Calibration with Structural Models: The Lehman case and Equity Swaps under Counterparty Risk," Papers 0912.4404, arXiv.org.
    5. Gordy, Michael B., 2003. "A risk-factor model foundation for ratings-based bank capital rules," Journal of Financial Intermediation, Elsevier, vol. 12(3), pages 199-232, July.
    6. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    7. Damiano Brigo & Aurélien Alfonsi, 2005. "Credit default swap calibration and derivatives pricing with the SSRD stochastic intensity model," Finance and Stochastics, Springer, vol. 9(1), pages 29-42, January.
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    Cited by:

    1. repec:wsi:ijtafx:v:18:y:2015:i:03:n:s0219024915500156 is not listed on IDEAS
    2. Tobias Niedrig & Helmut Gründl, 2015. "The Effects of Contingent Convertible (CoCo) Bonds on Insurers’ Capital Requirements Under Solvency II," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 40(3), pages 416-443, July.
    3. Jos'e Manuel Corcuera & Arturo Valdivia, 2016. "CoCos under short-term uncertainty," Papers 1602.00094, arXiv.org.
    4. Masror Khah, Sara Abed & Vermaelen, Theo & Wolff, Christian C, 2015. "The Determinants of CoCo Bond Prices," CEPR Discussion Papers 10996, C.E.P.R. Discussion Papers.
    5. Masayuki Kazato & Tetsuya Yamada, 2018. "The Implied Bail-in Probability in the Contingent Convertible Securities Market," IMES Discussion Paper Series 18-E-03, Institute for Monetary and Economic Studies, Bank of Japan.

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