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Europe's CoCos Provide a Lesson on Uncertainty

Author

Listed:
  • Katherine Gleason

    (Office of Financial Research)

  • Steve Bright

    (Office of Financial Research)

  • Francis Martinez

    (Office of Financial Research)

  • Charles Taylor

    (Office of Financial Research)

Abstract

Contingent convertible bonds (CoCos) issued by European global systemically important banks (GSIBs) as part of their total loss-absorbing capacity (TLAC) are meant to enhance financial stability by forcing investors to absorb losses when a bank is under stress. Coupon payments are made at issuers' discretion while loss absorption can be triggered at regulators' discretion. This study investigates price effects of four press releases by Deutsche Bank AG in February 2016 related to the bank's willingness and ability to make its upcoming CoCo coupon payments. Expected cash flow models capture changes in CoCo default risk, while event dates capture uncertainty effects. The price of a European G-SIB peer group portfolio declined a statistically significant 2.0-2.5 percent over two days in response to Deutsche Bank's first press release. Deutsche Bank's efforts to allay its own CoCo investors' concerns appeared to increase concerns among CoCo investors generally. The results show potential negative effects of regulatory discretion.

Suggested Citation

  • Katherine Gleason & Steve Bright & Francis Martinez & Charles Taylor, 2017. "Europe's CoCos Provide a Lesson on Uncertainty," Working Papers 17-02, Office of Financial Research, US Department of the Treasury.
    • Handle: RePEc:ofr:wpaper:17-02
    as

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    File URL: https://www.financialresearch.gov/working-papers/files/OFRwp-2017-02_Europes-CoCos-Provide-Lesson-on-Uncertainty.pdf
    File Function: First version, 2017
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    References listed on IDEAS

    as
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    4. Stefan Avdjiev & Anastasia Kartasheva & Bilyana Bogdanova, 2013. "CoCos: a primer," BIS Quarterly Review, Bank for International Settlements, September.
    5. Mr. Jorge A Chan-Lau, 2006. "Market-Based Estimation of Default Probabilities and its Application to Financial Market Surveillance," IMF Working Papers 2006/104, International Monetary Fund.
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    Cited by:

    1. Fiordelisi, Franco & Pennacchi, George & Ricci, Ornella, 2020. "Are contingent convertibles going-concern capital?," Journal of Financial Intermediation, Elsevier, vol. 43(C).

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