Coco Bonds Valuation with Equity- and Credit-Calibrated First Passage Structural Models

Abstract

After the beginning of the credit and liquidity crisis, financial institutions have been considering creating a convertible-bond type contract focusing on Capital. Under the terms of this contract, a bond is converted into equity if the authorities deem the institution to be under-capitalized. This paper discusses this Contingent Capital (or Coco) bond instrument and presents a pricing methodology based on firm value models. The model is calibrated to readily available market data. A stress test of model parameters is illustrated to account for potential model risk. Finally, a brief overview of how the instrument performs is presented.

CoCos under short-term uncertainty

“…Besides, as we shall see below, the obtainment of analytical formulas depends explicitly on the vector (U t , log S t ), not separately on (S t ) t≥0 and (ℓ t ) t≥0 . Moreover, this model accommodates also recent contributions on the study of CoCos such as [3,8]. Indeed we have the following.…”

“…Moreover, this model accommodates also recent contributions on the study of CoCos such as [3,8]. Indeed we have the following.…”

“…Indeed we have the following. [3] model corresponds to a one-dimensional case, where σ is a piecewise constant deterministic function, and a (in their notation a := B) is given as one of the model parameters. The correlation is assumed to equal to 1, so that…”

Implicit Trigger Price Determination for Contingent Convertible Bond

“…In this case the risk for the investor will be higher, due to possible significant losses. The main characteristics of the CoCo bonds will be analyzed in what follows, starting by defining bonds and hybrid bonds, for more details see, e.g., [7], [5], [4], [9], [2] and references therein, while we refer to, e.g., [1], [10], for an alternative methods to evaluate CoCo bonds, namely those based on structural models. The first part of the article, i.e.…”

“…Moreover, contracts with different technical as well as financial characteristics will be taken into account, see Sec. (4), by considering the parameters of CoCo bond contracts which are currently present in real financial markets. and Related algorithms, written by making use of pseudocode, are presented in Sec.…”