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Multiple buffer CoCos and their impact on financial stability

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  • Ioana Neamtu

    (University of Amsterdam)

Abstract

In this paper we develop a theoretical model to investigate the effect on a bank's financial stability of having multiple contingent convertible bonds buffers (CoCos) on the same bank balance sheet, using cash-in-the-market pricing and global games methodologies. Contingent convertible bonds are meant to act as a bail-in mechanism for banks, where CoCo debt converts into equity when a bank needs it the most. We find that having CoCo buffers which trigger at different capitalisation levels can be detrimental for the CoCo bail-in capacity. Market-based triggers lead to premature conversion and fire-sales of equity. In contrast with existing literature, we show that book-based trigger CoCos yield an optimal outcome, as long as they incorporate expected credit losses.

Suggested Citation

  • Ioana Neamtu, 2020. "Multiple buffer CoCos and their impact on financial stability," Tinbergen Institute Discussion Papers 20-010/IV, Tinbergen Institute.
  • Handle: RePEc:tin:wpaper:20200010
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    References listed on IDEAS

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    More about this item

    Keywords

    contingent convertible bonds; fire sales; financial stability;
    All these keywords.

    JEL classification:

    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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