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Mega-Banks' Self-Insurance with Cocos: A Work in Progress

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  • George M. von Furstenberg

    (Indiana University and Hong Kong Institute for Monetary Research)

Abstract

When contingently convertible debt securities trigger and convert into common equity well before the capital ratio of a financial institution has reached its regulatory minimum, they are known as going-concern or go-cocos. Their objective is to recapitalize an institution under stress and not to facilitate its resolution as would be the task of low-trigger goner-cocos. Because cocos are an "infant instrument" that grew out of the 2007-2009 crisis, few of their design features, their tax treatment or role in bond indexes are settled. Their portfolio fit with unsecured senior non-contingent debt on the one hand and common equity on the other is also an open question. Its resolution has much to do with how adding go-cocos may affect debt overhang in a firm. This paper attempts to clarify such underexposed open issues. Its chief contribution, however, lies in sifting through the experience with cocos triggers and conversion methods in order to link both actual, and one proposed, conversion methods to the recovery rates on cocos likely to be obtained from the common shares received by conversion. Experimenting with sparsely parameterized survival patterns that reach specified survival-rate levels after 10-years, and with the implied hazard rates and default rates conditional on survival, then allows a schedule of CDS premiums to be derived. These provide insight into the competitiveness of pricing the loss-of-value risk in go-cocos, instead of in the common-equity premium, over AAA-rated bonds.

Suggested Citation

  • George M. von Furstenberg, 2012. "Mega-Banks' Self-Insurance with Cocos: A Work in Progress," Working Papers 072012, Hong Kong Institute for Monetary Research.
  • Handle: RePEc:hkm:wpaper:072012
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    References listed on IDEAS

    as
    1. Ceyla Pazarbasioglu & Ms. Jianping Zhou & Mrs. Vanessa Le Lesle & Michael Moore, 2011. "Contingent Capital: Economic Rationale and Design Features," IMF Staff Discussion Notes 2011/001, International Monetary Fund.
    2. Calomiris, Charles W. & Herring, Richard J., 2011. "Why and How to Design a Contingent Convetible Debt Requirement," Working Papers 11-41, University of Pennsylvania, Wharton School, Weiss Center.
    3. George M. von Furstenberg, 2011. "Concocting Marketable Cocos," Working Papers 222011, Hong Kong Institute for Monetary Research.
    4. Fernandez, Pablo & Aguirreamalloa, Javier & Corres, Luis, 2011. "Market risk premium used in 56 countries in 2011: A survey with 6,014 answers," IESE Research Papers D/920, IESE Business School.
    5. Berg, Tobias & Kaserer, Christoph, 2011. "Convert-to-Surrender Bonds: A Proposal of How to Reduce Risk-Taking Incentives in the Banking System," VfS Annual Conference 2011 (Frankfurt, Main): The Order of the World Economy - Lessons from the Crisis 48737, Verein für Socialpolitik / German Economic Association.
    6. von Furstenberg, George M., 2011. "Contingent capital to strengthen the private safety net for financial institutions: Cocos to the rescue?," Discussion Paper Series 2: Banking and Financial Studies 2011,01, Deutsche Bundesbank.
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    Cited by:

    1. George M. von Furstenberg, 2014. "Bank Heal Thyself: Benefits of Adding CoCos to the Balance Sheet," CESifo Forum, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 15(3), pages 65-71, August.
    2. 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.
    3. George M. von Furstenberg, 2014. "Bank Heal Thyself: Benefits of Adding CoCos to the Balance Sheet," CESifo Forum, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 15(03), pages 65-71, August.

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    More about this item

    JEL classification:

    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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