ANALYTIC PRICING OF CoCo BONDS

Abstract

We present a new model for pricing contingent convertible (CoCo) bonds which facilitates the calculation of equity, credit and interest rate risk sensitivities. We assume a lognormal equity process and a Hull–White (normal) short rate process for the conversion intensity with a downward jump in the equity price on conversion. We are able to derive an approximate solution in closed form based on the assumption that the conversion intensity volatility is asymptotically small. The simple first-order approximation is seen to be accurate for a wide range of market conditions, although particularly for longer maturities higher order terms in the asymptotic expansion may be needed.

The determinants of banks' AT1 CoCo spreads

“…Promising research has been carried out on their valuation (Abed Masror Khah et al, 2019;Barucci & Del Viva, 2012;Chang & Yu, 2018;Chen et al, 2017;Chung & Kwok, 2016;Corcuera et al, 2014;Davis et al, 2014;de Spiegeleer et al, 2017;Leung & Kwok, 2017;Pennacchi & Tchistyi, 2019aPennacchi et al, 2014;Turfus & Shubert, 2017). However, theoretical contingent claim models, which are typically based on firm value (structural approach), credit default swaps (credit derivative approach), or dynamic replication with shares (equity derivative approach), often have difficulties taking contextual parameters into account.…”