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Contagion in the CoCos market? A case study of two stress events

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  • Pierluigi Bologna

    (Bank of Italy)

  • Arianna Miglietta

    (Bank of Italy)

  • Anatoli Segura

    (Bank of Italy)

Abstract

The post-crisis regulatory framework has fostered the development of the market for contingent convertible bonds (CoCos). These instruments allow for loss absorption as a going concern, but their critics warn about their potential destabilizing effects in stress situations. We analyze the dynamics of the European CoCos market during two stress episodes that occurred in 2016 and were triggered by news on substantial unexpected losses faced by a European systemic bank. Our econometric approach aims at disentangling the fundamental contagion channels of the distress of such bank to the rest of the market from a potential CoCo-specific contagion channel. We find evidence of significant CoCo-specific contagion in the first stress episode that could result from investors' reassessment of CoCos' riskiness or from uncertainty on their supervisory treatment. We do not find instead evidence of CoCospecific contagion in the second stress event, suggesting that as investors learn about the specificities of these instruments and their supervisory treatment, the CoCos market becomes more resilient.
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Pierluigi Bologna & Arianna Miglietta & Anatoli Segura, 2018. "Contagion in the CoCos market? A case study of two stress events," Temi di discussione (Economic working papers) 1201, Bank of Italy, Economic Research and International Relations Area.
  • Handle: RePEc:bdi:wptemi:td_1201_18
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    References listed on IDEAS

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    3. Concetta Rondinelli & Roberta Zizza, 2020. "Spend today or spend tomorrow? The role of inflation expectations in consumer behaviour," Temi di discussione (Economic working papers) 1276, Bank of Italy, Economic Research and International Relations Area.
    4. Luca Metelli & Filippo Natoli, 2021. "The International Transmission of US Tax Shocks: A Proxy-SVAR Approach," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 69(2), pages 325-356, June.
    5. Gaëtan Le Quang, 2019. "Mind the Conversion Risk: a Theoretical Assessment of Contingent Convertible Bonds," EconomiX Working Papers 2019-5, University of Paris Nanterre, EconomiX.
    6. Gaëtan Le Quang, 2019. "Mind the Conversion Risk: a Theoretical Assessment of Contingent Convertible Bonds," Working Papers hal-04141886, HAL.
    7. Elise Kremer & Bruno Tinel, 2022. "Contingent convertible bonds and macroeconomic stability in a stock‐flow consistent model," Metroeconomica, Wiley Blackwell, vol. 73(4), pages 1112-1154, November.
    8. 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.
    9. Pierre Durand & Gaëtan Le Quang & Arnold Vialfont, 2023. "Are Basel III requirements up to the task? Evidence from bankruptcy prediction models," Working Papers 2308, Groupe d'Analyse et de Théorie Economique Lyon St-Étienne (GATE Lyon St-Étienne), Université de Lyon.
    10. Durand, Pierre & Le Quang, Gaëtan, 2022. "Banks to basics! Why banking regulation should focus on equity," European Journal of Operational Research, Elsevier, vol. 301(1), pages 349-372.
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    More about this item

    Keywords

    The post-crisis regulatory framework has fostered the development of the contingent convertible bonds (CoCos) market. These instruments permit banks to absorb losses as a going concern but their critics warn that they could have potentially destabilizing effects in stress situations. We analyse the dynamics of the European CoCos market during two stress episodes that occurred in 2016 and that were triggered by news of substantial unexpected losses faced by a European systemically important bank. Our econometric approach aims to disentangle the fundamental channel by which the contagion of such bank’s distress spreads to the rest of the market from a possible CoCo-specific contagion channel. We find evidence of significant CoCo-specific contagion in the two stress episodes; which could be the result of investors’ reassessment of the CoCos’ riskiness or of uncertainty about their supervisory treatment. Moreover; we find that the CoCo-specific contagion was weaker in the second stress event; suggesting that as investors learn about the specific features of these instruments and their supervisory treatment the CoCos market becomes more resilient.;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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