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The Implied Bail-in Probability in the Contingent Convertible Securities Market

Author

Listed:
  • Masayuki Kazato

    (Deputy Director, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: masayuki.kazato@boj.or.jp))

  • Tetsuya Yamada

    (Director, Institute for Monetary and Economic Studies (currently Financial System and Bank Examination Department), Bank of Japan (E-mail: tetsuya.yamada@boj.or.jp))

Abstract

The issuance of contingent convertible securities (CoCos) has increased not only in Europe but also in Asia and other areas over the past several years. In this paper, we extend the existing model used to price CoCos to estimate the implied bail-in probability for a variety of CoCos by modifying loss rates for investors due to bail-ins of CoCos. Using our model for empirical analyses, we find that when the credit events occur, the bail-in probability of a CoCo increases by more than the default probability implied by credit default swaps (CDS). The result suggests that the bail-in probability can be used as an early warning indicator of financial crises. We also find that the conditional default probability after bail-in tends to be lower the more CoCos a bank has issued. This finding indicates that investors believe financial institutions become less likely to default as issuing more CoCos strengthens their loss absorption capacity. Overall, our analysis suggests that the market prices of CoCos contain useful information on financial stability.

Suggested Citation

  • 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.
    • Handle: RePEc:ime:imedps:18-e-03
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    References listed on IDEAS

    as
    1. Avdjiev, Stefan & Bogdanova, Bilyana & Bolton, Patrick & Jiang, Wei & Kartasheva, Anastasia, 2020. "CoCo issuance and bank fragility," Journal of Financial Economics, Elsevier, vol. 138(3), pages 593-613.
    2. Black, Fischer & Cox, John C, 1976. "Valuing Corporate Securities: Some Effects of Bond Indenture Provisions," Journal of Finance, American Finance Association, vol. 31(2), pages 351-367, May.
    3. 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.
    4. Koichiro Kamada, 2010. "Understanding Contingent Capital," Bank of Japan Working Paper Series 10-E-9, Bank of Japan.
    5. Jan De Spiegeleer & Stephan Höcht & Ine Marquet & Wim Schoutens, 2017. "CoCo bonds and implied CET1 volatility," Quantitative Finance, Taylor & Francis Journals, vol. 17(6), pages 813-824, June.
    6. Paul Glasserman & Behzad Nouri, 2012. "Contingent Capital with a Capital-Ratio Trigger," Management Science, INFORMS, vol. 58(10), pages 1816-1833, October.
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    Cited by:

    1. 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.

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    More about this item

    Keywords

    Market-implied bail-in probability; Contingent convertible securities; Basel III; Financial stability;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • 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
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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