on the design of contingent capital · 2018-04-03 · basic idea of contingent capital (cc) the...
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![Page 1: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/1.jpg)
On the Design of Contingent Capitalwith a Market Trigger
Suresh Sundaresan Zhenyu Wang
Columbia University Indiana University
The Journal of Finance
SW (CU,IU) Contingent Capital JF 1 / 23
![Page 2: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/2.jpg)
Basic idea of contingent capital (CC)
The capital functions as a debt in a good state/bank
It has a par value, which is the initial investmentIt pays interests regularly
The capital functions as equity in a bad state/bank
It stops paying interestsIt converts to certain shares of common equity
When and why to convert
Convert when the capital is lowRecapitalize the bank to avoid distress/bankruptcy
Why are banks interested in CC
Substitute equity in regulatory capital requirementsRaise funds without earnings dilutionDeduct interest payments from taxable income
SW (CU,IU) Contingent Capital JF 2 / 23
![Page 3: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/3.jpg)
Basic idea of contingent capital (CC)
The capital functions as a debt in a good state/bank
It has a par value, which is the initial investmentIt pays interests regularly
The capital functions as equity in a bad state/bank
It stops paying interestsIt converts to certain shares of common equity
When and why to convert
Convert when the capital is lowRecapitalize the bank to avoid distress/bankruptcy
Why are banks interested in CC
Substitute equity in regulatory capital requirementsRaise funds without earnings dilutionDeduct interest payments from taxable income
SW (CU,IU) Contingent Capital JF 2 / 23
![Page 4: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/4.jpg)
Basic idea of contingent capital (CC)
The capital functions as a debt in a good state/bank
It has a par value, which is the initial investment
It pays interests regularly
The capital functions as equity in a bad state/bank
It stops paying interestsIt converts to certain shares of common equity
When and why to convert
Convert when the capital is lowRecapitalize the bank to avoid distress/bankruptcy
Why are banks interested in CC
Substitute equity in regulatory capital requirementsRaise funds without earnings dilutionDeduct interest payments from taxable income
SW (CU,IU) Contingent Capital JF 2 / 23
![Page 5: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/5.jpg)
Basic idea of contingent capital (CC)
The capital functions as a debt in a good state/bank
It has a par value, which is the initial investmentIt pays interests regularly
The capital functions as equity in a bad state/bank
It stops paying interestsIt converts to certain shares of common equity
When and why to convert
Convert when the capital is lowRecapitalize the bank to avoid distress/bankruptcy
Why are banks interested in CC
Substitute equity in regulatory capital requirementsRaise funds without earnings dilutionDeduct interest payments from taxable income
SW (CU,IU) Contingent Capital JF 2 / 23
![Page 6: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/6.jpg)
Basic idea of contingent capital (CC)
The capital functions as a debt in a good state/bank
It has a par value, which is the initial investmentIt pays interests regularly
The capital functions as equity in a bad state/bank
It stops paying interestsIt converts to certain shares of common equity
When and why to convert
Convert when the capital is lowRecapitalize the bank to avoid distress/bankruptcy
Why are banks interested in CC
Substitute equity in regulatory capital requirementsRaise funds without earnings dilutionDeduct interest payments from taxable income
SW (CU,IU) Contingent Capital JF 2 / 23
![Page 7: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/7.jpg)
Basic idea of contingent capital (CC)
The capital functions as a debt in a good state/bank
It has a par value, which is the initial investmentIt pays interests regularly
The capital functions as equity in a bad state/bank
It stops paying interests
It converts to certain shares of common equity
When and why to convert
Convert when the capital is lowRecapitalize the bank to avoid distress/bankruptcy
Why are banks interested in CC
Substitute equity in regulatory capital requirementsRaise funds without earnings dilutionDeduct interest payments from taxable income
SW (CU,IU) Contingent Capital JF 2 / 23
![Page 8: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/8.jpg)
Basic idea of contingent capital (CC)
The capital functions as a debt in a good state/bank
It has a par value, which is the initial investmentIt pays interests regularly
The capital functions as equity in a bad state/bank
It stops paying interestsIt converts to certain shares of common equity
When and why to convert
Convert when the capital is lowRecapitalize the bank to avoid distress/bankruptcy
Why are banks interested in CC
Substitute equity in regulatory capital requirementsRaise funds without earnings dilutionDeduct interest payments from taxable income
SW (CU,IU) Contingent Capital JF 2 / 23
![Page 9: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/9.jpg)
Basic idea of contingent capital (CC)
The capital functions as a debt in a good state/bank
It has a par value, which is the initial investmentIt pays interests regularly
The capital functions as equity in a bad state/bank
It stops paying interestsIt converts to certain shares of common equity
When and why to convert
Convert when the capital is lowRecapitalize the bank to avoid distress/bankruptcy
Why are banks interested in CC
Substitute equity in regulatory capital requirementsRaise funds without earnings dilutionDeduct interest payments from taxable income
SW (CU,IU) Contingent Capital JF 2 / 23
![Page 10: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/10.jpg)
Basic idea of contingent capital (CC)
The capital functions as a debt in a good state/bank
It has a par value, which is the initial investmentIt pays interests regularly
The capital functions as equity in a bad state/bank
It stops paying interestsIt converts to certain shares of common equity
When and why to convert
Convert when the capital is low
Recapitalize the bank to avoid distress/bankruptcy
Why are banks interested in CC
Substitute equity in regulatory capital requirementsRaise funds without earnings dilutionDeduct interest payments from taxable income
SW (CU,IU) Contingent Capital JF 2 / 23
![Page 11: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/11.jpg)
Basic idea of contingent capital (CC)
The capital functions as a debt in a good state/bank
It has a par value, which is the initial investmentIt pays interests regularly
The capital functions as equity in a bad state/bank
It stops paying interestsIt converts to certain shares of common equity
When and why to convert
Convert when the capital is lowRecapitalize the bank to avoid distress/bankruptcy
Why are banks interested in CC
Substitute equity in regulatory capital requirementsRaise funds without earnings dilutionDeduct interest payments from taxable income
SW (CU,IU) Contingent Capital JF 2 / 23
![Page 12: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/12.jpg)
Basic idea of contingent capital (CC)
The capital functions as a debt in a good state/bank
It has a par value, which is the initial investmentIt pays interests regularly
The capital functions as equity in a bad state/bank
It stops paying interestsIt converts to certain shares of common equity
When and why to convert
Convert when the capital is lowRecapitalize the bank to avoid distress/bankruptcy
Why are banks interested in CC
Substitute equity in regulatory capital requirementsRaise funds without earnings dilutionDeduct interest payments from taxable income
SW (CU,IU) Contingent Capital JF 2 / 23
![Page 13: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/13.jpg)
Basic idea of contingent capital (CC)
The capital functions as a debt in a good state/bank
It has a par value, which is the initial investmentIt pays interests regularly
The capital functions as equity in a bad state/bank
It stops paying interestsIt converts to certain shares of common equity
When and why to convert
Convert when the capital is lowRecapitalize the bank to avoid distress/bankruptcy
Why are banks interested in CC
Substitute equity in regulatory capital requirements
Raise funds without earnings dilutionDeduct interest payments from taxable income
SW (CU,IU) Contingent Capital JF 2 / 23
![Page 14: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/14.jpg)
Basic idea of contingent capital (CC)
The capital functions as a debt in a good state/bank
It has a par value, which is the initial investmentIt pays interests regularly
The capital functions as equity in a bad state/bank
It stops paying interestsIt converts to certain shares of common equity
When and why to convert
Convert when the capital is lowRecapitalize the bank to avoid distress/bankruptcy
Why are banks interested in CC
Substitute equity in regulatory capital requirementsRaise funds without earnings dilution
Deduct interest payments from taxable income
SW (CU,IU) Contingent Capital JF 2 / 23
![Page 15: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/15.jpg)
Basic idea of contingent capital (CC)
The capital functions as a debt in a good state/bank
It has a par value, which is the initial investmentIt pays interests regularly
The capital functions as equity in a bad state/bank
It stops paying interestsIt converts to certain shares of common equity
When and why to convert
Convert when the capital is lowRecapitalize the bank to avoid distress/bankruptcy
Why are banks interested in CC
Substitute equity in regulatory capital requirementsRaise funds without earnings dilutionDeduct interest payments from taxable income
SW (CU,IU) Contingent Capital JF 2 / 23
![Page 16: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/16.jpg)
Regulators’ objectives
Policy decisions after the financial crisis
Dodd-Frank Act: does CC enhance financial stability?Basel: allow banks to use CC as substitutes of equity?
Arguments for using CC to substitute equity
Overcome the reluctance of raising equity early
Avoid earning dilution in profitable banksLess costly for banks with debt overhung problem
Provides capital to absorb losses to avoid distress
Conversion should be mandatory and timelyRecapitalize the bank as going concern
Curtail the incentives of excessive risk-taking
Conversion must transfer value from equity to CCPunish managers for risking CC conversion
SW (CU,IU) Contingent Capital JF 3 / 23
![Page 17: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/17.jpg)
Regulators’ objectives
Policy decisions after the financial crisis
Dodd-Frank Act: does CC enhance financial stability?Basel: allow banks to use CC as substitutes of equity?
Arguments for using CC to substitute equity
Overcome the reluctance of raising equity early
Avoid earning dilution in profitable banksLess costly for banks with debt overhung problem
Provides capital to absorb losses to avoid distress
Conversion should be mandatory and timelyRecapitalize the bank as going concern
Curtail the incentives of excessive risk-taking
Conversion must transfer value from equity to CCPunish managers for risking CC conversion
SW (CU,IU) Contingent Capital JF 3 / 23
![Page 18: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/18.jpg)
Regulators’ objectives
Policy decisions after the financial crisis
Dodd-Frank Act: does CC enhance financial stability?
Basel: allow banks to use CC as substitutes of equity?
Arguments for using CC to substitute equity
Overcome the reluctance of raising equity early
Avoid earning dilution in profitable banksLess costly for banks with debt overhung problem
Provides capital to absorb losses to avoid distress
Conversion should be mandatory and timelyRecapitalize the bank as going concern
Curtail the incentives of excessive risk-taking
Conversion must transfer value from equity to CCPunish managers for risking CC conversion
SW (CU,IU) Contingent Capital JF 3 / 23
![Page 19: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/19.jpg)
Regulators’ objectives
Policy decisions after the financial crisis
Dodd-Frank Act: does CC enhance financial stability?Basel: allow banks to use CC as substitutes of equity?
Arguments for using CC to substitute equity
Overcome the reluctance of raising equity early
Avoid earning dilution in profitable banksLess costly for banks with debt overhung problem
Provides capital to absorb losses to avoid distress
Conversion should be mandatory and timelyRecapitalize the bank as going concern
Curtail the incentives of excessive risk-taking
Conversion must transfer value from equity to CCPunish managers for risking CC conversion
SW (CU,IU) Contingent Capital JF 3 / 23
![Page 20: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/20.jpg)
Regulators’ objectives
Policy decisions after the financial crisis
Dodd-Frank Act: does CC enhance financial stability?Basel: allow banks to use CC as substitutes of equity?
Arguments for using CC to substitute equity
Overcome the reluctance of raising equity early
Avoid earning dilution in profitable banksLess costly for banks with debt overhung problem
Provides capital to absorb losses to avoid distress
Conversion should be mandatory and timelyRecapitalize the bank as going concern
Curtail the incentives of excessive risk-taking
Conversion must transfer value from equity to CCPunish managers for risking CC conversion
SW (CU,IU) Contingent Capital JF 3 / 23
![Page 21: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/21.jpg)
Regulators’ objectives
Policy decisions after the financial crisis
Dodd-Frank Act: does CC enhance financial stability?Basel: allow banks to use CC as substitutes of equity?
Arguments for using CC to substitute equity
Overcome the reluctance of raising equity early
Avoid earning dilution in profitable banksLess costly for banks with debt overhung problem
Provides capital to absorb losses to avoid distress
Conversion should be mandatory and timelyRecapitalize the bank as going concern
Curtail the incentives of excessive risk-taking
Conversion must transfer value from equity to CCPunish managers for risking CC conversion
SW (CU,IU) Contingent Capital JF 3 / 23
![Page 22: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/22.jpg)
Regulators’ objectives
Policy decisions after the financial crisis
Dodd-Frank Act: does CC enhance financial stability?Basel: allow banks to use CC as substitutes of equity?
Arguments for using CC to substitute equity
Overcome the reluctance of raising equity early
Avoid earning dilution in profitable banks
Less costly for banks with debt overhung problem
Provides capital to absorb losses to avoid distress
Conversion should be mandatory and timelyRecapitalize the bank as going concern
Curtail the incentives of excessive risk-taking
Conversion must transfer value from equity to CCPunish managers for risking CC conversion
SW (CU,IU) Contingent Capital JF 3 / 23
![Page 23: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/23.jpg)
Regulators’ objectives
Policy decisions after the financial crisis
Dodd-Frank Act: does CC enhance financial stability?Basel: allow banks to use CC as substitutes of equity?
Arguments for using CC to substitute equity
Overcome the reluctance of raising equity early
Avoid earning dilution in profitable banksLess costly for banks with debt overhung problem
Provides capital to absorb losses to avoid distress
Conversion should be mandatory and timelyRecapitalize the bank as going concern
Curtail the incentives of excessive risk-taking
Conversion must transfer value from equity to CCPunish managers for risking CC conversion
SW (CU,IU) Contingent Capital JF 3 / 23
![Page 24: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/24.jpg)
Regulators’ objectives
Policy decisions after the financial crisis
Dodd-Frank Act: does CC enhance financial stability?Basel: allow banks to use CC as substitutes of equity?
Arguments for using CC to substitute equity
Overcome the reluctance of raising equity early
Avoid earning dilution in profitable banksLess costly for banks with debt overhung problem
Provides capital to absorb losses to avoid distress
Conversion should be mandatory and timelyRecapitalize the bank as going concern
Curtail the incentives of excessive risk-taking
Conversion must transfer value from equity to CCPunish managers for risking CC conversion
SW (CU,IU) Contingent Capital JF 3 / 23
![Page 25: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/25.jpg)
Regulators’ objectives
Policy decisions after the financial crisis
Dodd-Frank Act: does CC enhance financial stability?Basel: allow banks to use CC as substitutes of equity?
Arguments for using CC to substitute equity
Overcome the reluctance of raising equity early
Avoid earning dilution in profitable banksLess costly for banks with debt overhung problem
Provides capital to absorb losses to avoid distress
Conversion should be mandatory and timely
Recapitalize the bank as going concern
Curtail the incentives of excessive risk-taking
Conversion must transfer value from equity to CCPunish managers for risking CC conversion
SW (CU,IU) Contingent Capital JF 3 / 23
![Page 26: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/26.jpg)
Regulators’ objectives
Policy decisions after the financial crisis
Dodd-Frank Act: does CC enhance financial stability?Basel: allow banks to use CC as substitutes of equity?
Arguments for using CC to substitute equity
Overcome the reluctance of raising equity early
Avoid earning dilution in profitable banksLess costly for banks with debt overhung problem
Provides capital to absorb losses to avoid distress
Conversion should be mandatory and timelyRecapitalize the bank as going concern
Curtail the incentives of excessive risk-taking
Conversion must transfer value from equity to CCPunish managers for risking CC conversion
SW (CU,IU) Contingent Capital JF 3 / 23
![Page 27: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/27.jpg)
Regulators’ objectives
Policy decisions after the financial crisis
Dodd-Frank Act: does CC enhance financial stability?Basel: allow banks to use CC as substitutes of equity?
Arguments for using CC to substitute equity
Overcome the reluctance of raising equity early
Avoid earning dilution in profitable banksLess costly for banks with debt overhung problem
Provides capital to absorb losses to avoid distress
Conversion should be mandatory and timelyRecapitalize the bank as going concern
Curtail the incentives of excessive risk-taking
Conversion must transfer value from equity to CCPunish managers for risking CC conversion
SW (CU,IU) Contingent Capital JF 3 / 23
![Page 28: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/28.jpg)
Regulators’ objectives
Policy decisions after the financial crisis
Dodd-Frank Act: does CC enhance financial stability?Basel: allow banks to use CC as substitutes of equity?
Arguments for using CC to substitute equity
Overcome the reluctance of raising equity early
Avoid earning dilution in profitable banksLess costly for banks with debt overhung problem
Provides capital to absorb losses to avoid distress
Conversion should be mandatory and timelyRecapitalize the bank as going concern
Curtail the incentives of excessive risk-taking
Conversion must transfer value from equity to CC
Punish managers for risking CC conversion
SW (CU,IU) Contingent Capital JF 3 / 23
![Page 29: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/29.jpg)
Regulators’ objectives
Policy decisions after the financial crisis
Dodd-Frank Act: does CC enhance financial stability?Basel: allow banks to use CC as substitutes of equity?
Arguments for using CC to substitute equity
Overcome the reluctance of raising equity early
Avoid earning dilution in profitable banksLess costly for banks with debt overhung problem
Provides capital to absorb losses to avoid distress
Conversion should be mandatory and timelyRecapitalize the bank as going concern
Curtail the incentives of excessive risk-taking
Conversion must transfer value from equity to CCPunish managers for risking CC conversion
SW (CU,IU) Contingent Capital JF 3 / 23
![Page 30: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/30.jpg)
Some contingent capitals issued so far
02/25/09, TARP (CAP or MCP)
Option for a bank to convert
11/05/09, Lloyds’s Enhanced Capital Notes
Accounting trigger: T1/RWA 5%
03/12/10, Rabobank’s Senior Contingent Notes
Accounting trigger: T1/RWA 7%
02/14/11, Credit Suisse’s Bu↵er Capital Notes
Dual triggers: E/RWA 7% or SNB decision
02/15/12 & 08/10/12, UBS Tier 2 Subordinated Notes
Dual triggers: CT1/RWA 5% or SNB decision
11/13/12 & 04/04/13, Barclays Bank Plc CC Notes
Accounting trigger: CT1/RWA 7%
01/18/13, KBC Contingent Capital Securities
Accounting trigger: CT1/RWA 7%
SW (CU,IU) Contingent Capital JF 4 / 23
![Page 31: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/31.jpg)
Some contingent capitals issued so far
02/25/09, TARP (CAP or MCP)
Option for a bank to convert
11/05/09, Lloyds’s Enhanced Capital Notes
Accounting trigger: T1/RWA 5%
03/12/10, Rabobank’s Senior Contingent Notes
Accounting trigger: T1/RWA 7%
02/14/11, Credit Suisse’s Bu↵er Capital Notes
Dual triggers: E/RWA 7% or SNB decision
02/15/12 & 08/10/12, UBS Tier 2 Subordinated Notes
Dual triggers: CT1/RWA 5% or SNB decision
11/13/12 & 04/04/13, Barclays Bank Plc CC Notes
Accounting trigger: CT1/RWA 7%
01/18/13, KBC Contingent Capital Securities
Accounting trigger: CT1/RWA 7%
SW (CU,IU) Contingent Capital JF 4 / 23
![Page 32: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/32.jpg)
Some contingent capitals issued so far
02/25/09, TARP (CAP or MCP)Option for a bank to convert
11/05/09, Lloyds’s Enhanced Capital Notes
Accounting trigger: T1/RWA 5%
03/12/10, Rabobank’s Senior Contingent Notes
Accounting trigger: T1/RWA 7%
02/14/11, Credit Suisse’s Bu↵er Capital Notes
Dual triggers: E/RWA 7% or SNB decision
02/15/12 & 08/10/12, UBS Tier 2 Subordinated Notes
Dual triggers: CT1/RWA 5% or SNB decision
11/13/12 & 04/04/13, Barclays Bank Plc CC Notes
Accounting trigger: CT1/RWA 7%
01/18/13, KBC Contingent Capital Securities
Accounting trigger: CT1/RWA 7%
SW (CU,IU) Contingent Capital JF 4 / 23
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Some contingent capitals issued so far
02/25/09, TARP (CAP or MCP)Option for a bank to convert
11/05/09, Lloyds’s Enhanced Capital Notes
Accounting trigger: T1/RWA 5%
03/12/10, Rabobank’s Senior Contingent Notes
Accounting trigger: T1/RWA 7%
02/14/11, Credit Suisse’s Bu↵er Capital Notes
Dual triggers: E/RWA 7% or SNB decision
02/15/12 & 08/10/12, UBS Tier 2 Subordinated Notes
Dual triggers: CT1/RWA 5% or SNB decision
11/13/12 & 04/04/13, Barclays Bank Plc CC Notes
Accounting trigger: CT1/RWA 7%
01/18/13, KBC Contingent Capital Securities
Accounting trigger: CT1/RWA 7%
SW (CU,IU) Contingent Capital JF 4 / 23
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Some contingent capitals issued so far
02/25/09, TARP (CAP or MCP)Option for a bank to convert
11/05/09, Lloyds’s Enhanced Capital NotesAccounting trigger: T1/RWA 5%
03/12/10, Rabobank’s Senior Contingent Notes
Accounting trigger: T1/RWA 7%
02/14/11, Credit Suisse’s Bu↵er Capital Notes
Dual triggers: E/RWA 7% or SNB decision
02/15/12 & 08/10/12, UBS Tier 2 Subordinated Notes
Dual triggers: CT1/RWA 5% or SNB decision
11/13/12 & 04/04/13, Barclays Bank Plc CC Notes
Accounting trigger: CT1/RWA 7%
01/18/13, KBC Contingent Capital Securities
Accounting trigger: CT1/RWA 7%
SW (CU,IU) Contingent Capital JF 4 / 23
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Some contingent capitals issued so far
02/25/09, TARP (CAP or MCP)Option for a bank to convert
11/05/09, Lloyds’s Enhanced Capital NotesAccounting trigger: T1/RWA 5%
03/12/10, Rabobank’s Senior Contingent Notes
Accounting trigger: T1/RWA 7%
02/14/11, Credit Suisse’s Bu↵er Capital Notes
Dual triggers: E/RWA 7% or SNB decision
02/15/12 & 08/10/12, UBS Tier 2 Subordinated Notes
Dual triggers: CT1/RWA 5% or SNB decision
11/13/12 & 04/04/13, Barclays Bank Plc CC Notes
Accounting trigger: CT1/RWA 7%
01/18/13, KBC Contingent Capital Securities
Accounting trigger: CT1/RWA 7%
SW (CU,IU) Contingent Capital JF 4 / 23
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Some contingent capitals issued so far
02/25/09, TARP (CAP or MCP)Option for a bank to convert
11/05/09, Lloyds’s Enhanced Capital NotesAccounting trigger: T1/RWA 5%
03/12/10, Rabobank’s Senior Contingent NotesAccounting trigger: T1/RWA 7%
02/14/11, Credit Suisse’s Bu↵er Capital Notes
Dual triggers: E/RWA 7% or SNB decision
02/15/12 & 08/10/12, UBS Tier 2 Subordinated Notes
Dual triggers: CT1/RWA 5% or SNB decision
11/13/12 & 04/04/13, Barclays Bank Plc CC Notes
Accounting trigger: CT1/RWA 7%
01/18/13, KBC Contingent Capital Securities
Accounting trigger: CT1/RWA 7%
SW (CU,IU) Contingent Capital JF 4 / 23
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Some contingent capitals issued so far
02/25/09, TARP (CAP or MCP)Option for a bank to convert
11/05/09, Lloyds’s Enhanced Capital NotesAccounting trigger: T1/RWA 5%
03/12/10, Rabobank’s Senior Contingent NotesAccounting trigger: T1/RWA 7%
02/14/11, Credit Suisse’s Bu↵er Capital Notes
Dual triggers: E/RWA 7% or SNB decision
02/15/12 & 08/10/12, UBS Tier 2 Subordinated Notes
Dual triggers: CT1/RWA 5% or SNB decision
11/13/12 & 04/04/13, Barclays Bank Plc CC Notes
Accounting trigger: CT1/RWA 7%
01/18/13, KBC Contingent Capital Securities
Accounting trigger: CT1/RWA 7%
SW (CU,IU) Contingent Capital JF 4 / 23
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Some contingent capitals issued so far
02/25/09, TARP (CAP or MCP)Option for a bank to convert
11/05/09, Lloyds’s Enhanced Capital NotesAccounting trigger: T1/RWA 5%
03/12/10, Rabobank’s Senior Contingent NotesAccounting trigger: T1/RWA 7%
02/14/11, Credit Suisse’s Bu↵er Capital NotesDual triggers: E/RWA 7% or SNB decision
02/15/12 & 08/10/12, UBS Tier 2 Subordinated Notes
Dual triggers: CT1/RWA 5% or SNB decision
11/13/12 & 04/04/13, Barclays Bank Plc CC Notes
Accounting trigger: CT1/RWA 7%
01/18/13, KBC Contingent Capital Securities
Accounting trigger: CT1/RWA 7%
SW (CU,IU) Contingent Capital JF 4 / 23
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Some contingent capitals issued so far
02/25/09, TARP (CAP or MCP)Option for a bank to convert
11/05/09, Lloyds’s Enhanced Capital NotesAccounting trigger: T1/RWA 5%
03/12/10, Rabobank’s Senior Contingent NotesAccounting trigger: T1/RWA 7%
02/14/11, Credit Suisse’s Bu↵er Capital NotesDual triggers: E/RWA 7% or SNB decision
02/15/12 & 08/10/12, UBS Tier 2 Subordinated Notes
Dual triggers: CT1/RWA 5% or SNB decision
11/13/12 & 04/04/13, Barclays Bank Plc CC Notes
Accounting trigger: CT1/RWA 7%
01/18/13, KBC Contingent Capital Securities
Accounting trigger: CT1/RWA 7%
SW (CU,IU) Contingent Capital JF 4 / 23
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Some contingent capitals issued so far
02/25/09, TARP (CAP or MCP)Option for a bank to convert
11/05/09, Lloyds’s Enhanced Capital NotesAccounting trigger: T1/RWA 5%
03/12/10, Rabobank’s Senior Contingent NotesAccounting trigger: T1/RWA 7%
02/14/11, Credit Suisse’s Bu↵er Capital NotesDual triggers: E/RWA 7% or SNB decision
02/15/12 & 08/10/12, UBS Tier 2 Subordinated NotesDual triggers: CT1/RWA 5% or SNB decision
11/13/12 & 04/04/13, Barclays Bank Plc CC Notes
Accounting trigger: CT1/RWA 7%
01/18/13, KBC Contingent Capital Securities
Accounting trigger: CT1/RWA 7%
SW (CU,IU) Contingent Capital JF 4 / 23
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Some contingent capitals issued so far
02/25/09, TARP (CAP or MCP)Option for a bank to convert
11/05/09, Lloyds’s Enhanced Capital NotesAccounting trigger: T1/RWA 5%
03/12/10, Rabobank’s Senior Contingent NotesAccounting trigger: T1/RWA 7%
02/14/11, Credit Suisse’s Bu↵er Capital NotesDual triggers: E/RWA 7% or SNB decision
02/15/12 & 08/10/12, UBS Tier 2 Subordinated NotesDual triggers: CT1/RWA 5% or SNB decision
11/13/12 & 04/04/13, Barclays Bank Plc CC Notes
Accounting trigger: CT1/RWA 7%
01/18/13, KBC Contingent Capital Securities
Accounting trigger: CT1/RWA 7%
SW (CU,IU) Contingent Capital JF 4 / 23
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Some contingent capitals issued so far
02/25/09, TARP (CAP or MCP)Option for a bank to convert
11/05/09, Lloyds’s Enhanced Capital NotesAccounting trigger: T1/RWA 5%
03/12/10, Rabobank’s Senior Contingent NotesAccounting trigger: T1/RWA 7%
02/14/11, Credit Suisse’s Bu↵er Capital NotesDual triggers: E/RWA 7% or SNB decision
02/15/12 & 08/10/12, UBS Tier 2 Subordinated NotesDual triggers: CT1/RWA 5% or SNB decision
11/13/12 & 04/04/13, Barclays Bank Plc CC NotesAccounting trigger: CT1/RWA 7%
01/18/13, KBC Contingent Capital Securities
Accounting trigger: CT1/RWA 7%
SW (CU,IU) Contingent Capital JF 4 / 23
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Some contingent capitals issued so far
02/25/09, TARP (CAP or MCP)Option for a bank to convert
11/05/09, Lloyds’s Enhanced Capital NotesAccounting trigger: T1/RWA 5%
03/12/10, Rabobank’s Senior Contingent NotesAccounting trigger: T1/RWA 7%
02/14/11, Credit Suisse’s Bu↵er Capital NotesDual triggers: E/RWA 7% or SNB decision
02/15/12 & 08/10/12, UBS Tier 2 Subordinated NotesDual triggers: CT1/RWA 5% or SNB decision
11/13/12 & 04/04/13, Barclays Bank Plc CC NotesAccounting trigger: CT1/RWA 7%
01/18/13, KBC Contingent Capital Securities
Accounting trigger: CT1/RWA 7%
SW (CU,IU) Contingent Capital JF 4 / 23
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Some contingent capitals issued so far
02/25/09, TARP (CAP or MCP)Option for a bank to convert
11/05/09, Lloyds’s Enhanced Capital NotesAccounting trigger: T1/RWA 5%
03/12/10, Rabobank’s Senior Contingent NotesAccounting trigger: T1/RWA 7%
02/14/11, Credit Suisse’s Bu↵er Capital NotesDual triggers: E/RWA 7% or SNB decision
02/15/12 & 08/10/12, UBS Tier 2 Subordinated NotesDual triggers: CT1/RWA 5% or SNB decision
11/13/12 & 04/04/13, Barclays Bank Plc CC NotesAccounting trigger: CT1/RWA 7%
01/18/13, KBC Contingent Capital SecuritiesAccounting trigger: CT1/RWA 7%
SW (CU,IU) Contingent Capital JF 4 / 23
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Advocates for market triggers
Concerns with bank option
reluctance to convert; hoping for the best or bailout
Concerns with accounting triggers
management manipulation, backward lookingrecent crisis: troubled banks had high accounting ratios
Concerns with regulatory triggers
regulator’s information & monitoring are limitedpolitical pressure: worry about false alarms; late action
Potential advantages of market triggers
force banks to convert (no management or TBTF mentality)aggregate market info (not limited, di�cult to manipulate)timely information and action (not obsolete, no delay)objective rules (market view, no politics)
SW (CU,IU) Contingent Capital JF 5 / 23
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Advocates for market triggers
Concerns with bank option
reluctance to convert; hoping for the best or bailout
Concerns with accounting triggers
management manipulation, backward lookingrecent crisis: troubled banks had high accounting ratios
Concerns with regulatory triggers
regulator’s information & monitoring are limitedpolitical pressure: worry about false alarms; late action
Potential advantages of market triggers
force banks to convert (no management or TBTF mentality)aggregate market info (not limited, di�cult to manipulate)timely information and action (not obsolete, no delay)objective rules (market view, no politics)
SW (CU,IU) Contingent Capital JF 5 / 23
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Advocates for market triggers
Concerns with bank option
reluctance to convert; hoping for the best or bailout
Concerns with accounting triggers
management manipulation, backward lookingrecent crisis: troubled banks had high accounting ratios
Concerns with regulatory triggers
regulator’s information & monitoring are limitedpolitical pressure: worry about false alarms; late action
Potential advantages of market triggers
force banks to convert (no management or TBTF mentality)aggregate market info (not limited, di�cult to manipulate)timely information and action (not obsolete, no delay)objective rules (market view, no politics)
SW (CU,IU) Contingent Capital JF 5 / 23
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Advocates for market triggers
Concerns with bank option
reluctance to convert; hoping for the best or bailout
Concerns with accounting triggers
management manipulation, backward lookingrecent crisis: troubled banks had high accounting ratios
Concerns with regulatory triggers
regulator’s information & monitoring are limitedpolitical pressure: worry about false alarms; late action
Potential advantages of market triggers
force banks to convert (no management or TBTF mentality)aggregate market info (not limited, di�cult to manipulate)timely information and action (not obsolete, no delay)objective rules (market view, no politics)
SW (CU,IU) Contingent Capital JF 5 / 23
![Page 49: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/49.jpg)
Advocates for market triggers
Concerns with bank option
reluctance to convert; hoping for the best or bailout
Concerns with accounting triggers
management manipulation, backward looking
recent crisis: troubled banks had high accounting ratios
Concerns with regulatory triggers
regulator’s information & monitoring are limitedpolitical pressure: worry about false alarms; late action
Potential advantages of market triggers
force banks to convert (no management or TBTF mentality)aggregate market info (not limited, di�cult to manipulate)timely information and action (not obsolete, no delay)objective rules (market view, no politics)
SW (CU,IU) Contingent Capital JF 5 / 23
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Advocates for market triggers
Concerns with bank option
reluctance to convert; hoping for the best or bailout
Concerns with accounting triggers
management manipulation, backward lookingrecent crisis: troubled banks had high accounting ratios
Concerns with regulatory triggers
regulator’s information & monitoring are limitedpolitical pressure: worry about false alarms; late action
Potential advantages of market triggers
force banks to convert (no management or TBTF mentality)aggregate market info (not limited, di�cult to manipulate)timely information and action (not obsolete, no delay)objective rules (market view, no politics)
SW (CU,IU) Contingent Capital JF 5 / 23
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Advocates for market triggers
Concerns with bank option
reluctance to convert; hoping for the best or bailout
Concerns with accounting triggers
management manipulation, backward lookingrecent crisis: troubled banks had high accounting ratios
Concerns with regulatory triggers
regulator’s information & monitoring are limitedpolitical pressure: worry about false alarms; late action
Potential advantages of market triggers
force banks to convert (no management or TBTF mentality)aggregate market info (not limited, di�cult to manipulate)timely information and action (not obsolete, no delay)objective rules (market view, no politics)
SW (CU,IU) Contingent Capital JF 5 / 23
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Advocates for market triggers
Concerns with bank option
reluctance to convert; hoping for the best or bailout
Concerns with accounting triggers
management manipulation, backward lookingrecent crisis: troubled banks had high accounting ratios
Concerns with regulatory triggers
regulator’s information & monitoring are limited
political pressure: worry about false alarms; late action
Potential advantages of market triggers
force banks to convert (no management or TBTF mentality)aggregate market info (not limited, di�cult to manipulate)timely information and action (not obsolete, no delay)objective rules (market view, no politics)
SW (CU,IU) Contingent Capital JF 5 / 23
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Advocates for market triggers
Concerns with bank option
reluctance to convert; hoping for the best or bailout
Concerns with accounting triggers
management manipulation, backward lookingrecent crisis: troubled banks had high accounting ratios
Concerns with regulatory triggers
regulator’s information & monitoring are limitedpolitical pressure: worry about false alarms; late action
Potential advantages of market triggers
force banks to convert (no management or TBTF mentality)aggregate market info (not limited, di�cult to manipulate)timely information and action (not obsolete, no delay)objective rules (market view, no politics)
SW (CU,IU) Contingent Capital JF 5 / 23
![Page 54: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/54.jpg)
Advocates for market triggers
Concerns with bank option
reluctance to convert; hoping for the best or bailout
Concerns with accounting triggers
management manipulation, backward lookingrecent crisis: troubled banks had high accounting ratios
Concerns with regulatory triggers
regulator’s information & monitoring are limitedpolitical pressure: worry about false alarms; late action
Potential advantages of market triggers
force banks to convert (no management or TBTF mentality)aggregate market info (not limited, di�cult to manipulate)timely information and action (not obsolete, no delay)objective rules (market view, no politics)
SW (CU,IU) Contingent Capital JF 5 / 23
![Page 55: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/55.jpg)
Advocates for market triggers
Concerns with bank option
reluctance to convert; hoping for the best or bailout
Concerns with accounting triggers
management manipulation, backward lookingrecent crisis: troubled banks had high accounting ratios
Concerns with regulatory triggers
regulator’s information & monitoring are limitedpolitical pressure: worry about false alarms; late action
Potential advantages of market triggers
force banks to convert (no management or TBTF mentality)
aggregate market info (not limited, di�cult to manipulate)timely information and action (not obsolete, no delay)objective rules (market view, no politics)
SW (CU,IU) Contingent Capital JF 5 / 23
![Page 56: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/56.jpg)
Advocates for market triggers
Concerns with bank option
reluctance to convert; hoping for the best or bailout
Concerns with accounting triggers
management manipulation, backward lookingrecent crisis: troubled banks had high accounting ratios
Concerns with regulatory triggers
regulator’s information & monitoring are limitedpolitical pressure: worry about false alarms; late action
Potential advantages of market triggers
force banks to convert (no management or TBTF mentality)aggregate market info (not limited, di�cult to manipulate)
timely information and action (not obsolete, no delay)objective rules (market view, no politics)
SW (CU,IU) Contingent Capital JF 5 / 23
![Page 57: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/57.jpg)
Advocates for market triggers
Concerns with bank option
reluctance to convert; hoping for the best or bailout
Concerns with accounting triggers
management manipulation, backward lookingrecent crisis: troubled banks had high accounting ratios
Concerns with regulatory triggers
regulator’s information & monitoring are limitedpolitical pressure: worry about false alarms; late action
Potential advantages of market triggers
force banks to convert (no management or TBTF mentality)aggregate market info (not limited, di�cult to manipulate)timely information and action (not obsolete, no delay)
objective rules (market view, no politics)
SW (CU,IU) Contingent Capital JF 5 / 23
![Page 58: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/58.jpg)
Advocates for market triggers
Concerns with bank option
reluctance to convert; hoping for the best or bailout
Concerns with accounting triggers
management manipulation, backward lookingrecent crisis: troubled banks had high accounting ratios
Concerns with regulatory triggers
regulator’s information & monitoring are limitedpolitical pressure: worry about false alarms; late action
Potential advantages of market triggers
force banks to convert (no management or TBTF mentality)aggregate market info (not limited, di�cult to manipulate)timely information and action (not obsolete, no delay)objective rules (market view, no politics)
SW (CU,IU) Contingent Capital JF 5 / 23
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Proposals of market triggers
Triggers
Flannery (2009): convert if E/RWA x%Hart and Zingales (2010): convert if CDS spread � x bpsPennacchi (2011): convert if CC+E/deposit x%McDonald (2011): convert if ��E � x% and ��(Index) � y%
Where to place a market trigger?
If the bank is expected to experience large losses
the value of financial claims of a bank drops
A CC protects all claims that are senior to it, not junior
junior claims signal the stress more than senior claims
Triggers should be placed on claims junior to CC
the only claim junior to CC is common equity
SW (CU,IU) Contingent Capital JF 6 / 23
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Proposals of market triggers
Triggers
Flannery (2009): convert if E/RWA x%Hart and Zingales (2010): convert if CDS spread � x bpsPennacchi (2011): convert if CC+E/deposit x%McDonald (2011): convert if ��E � x% and ��(Index) � y%
Where to place a market trigger?
If the bank is expected to experience large losses
the value of financial claims of a bank drops
A CC protects all claims that are senior to it, not junior
junior claims signal the stress more than senior claims
Triggers should be placed on claims junior to CC
the only claim junior to CC is common equity
SW (CU,IU) Contingent Capital JF 6 / 23
![Page 61: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/61.jpg)
Proposals of market triggers
Triggers
Flannery (2009): convert if E/RWA x%
Hart and Zingales (2010): convert if CDS spread � x bpsPennacchi (2011): convert if CC+E/deposit x%McDonald (2011): convert if ��E � x% and ��(Index) � y%
Where to place a market trigger?
If the bank is expected to experience large losses
the value of financial claims of a bank drops
A CC protects all claims that are senior to it, not junior
junior claims signal the stress more than senior claims
Triggers should be placed on claims junior to CC
the only claim junior to CC is common equity
SW (CU,IU) Contingent Capital JF 6 / 23
![Page 62: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/62.jpg)
Proposals of market triggers
Triggers
Flannery (2009): convert if E/RWA x%Hart and Zingales (2010): convert if CDS spread � x bps
Pennacchi (2011): convert if CC+E/deposit x%McDonald (2011): convert if ��E � x% and ��(Index) � y%
Where to place a market trigger?
If the bank is expected to experience large losses
the value of financial claims of a bank drops
A CC protects all claims that are senior to it, not junior
junior claims signal the stress more than senior claims
Triggers should be placed on claims junior to CC
the only claim junior to CC is common equity
SW (CU,IU) Contingent Capital JF 6 / 23
![Page 63: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/63.jpg)
Proposals of market triggers
Triggers
Flannery (2009): convert if E/RWA x%Hart and Zingales (2010): convert if CDS spread � x bpsPennacchi (2011): convert if CC+E/deposit x%
McDonald (2011): convert if ��E � x% and ��(Index) � y%
Where to place a market trigger?
If the bank is expected to experience large losses
the value of financial claims of a bank drops
A CC protects all claims that are senior to it, not junior
junior claims signal the stress more than senior claims
Triggers should be placed on claims junior to CC
the only claim junior to CC is common equity
SW (CU,IU) Contingent Capital JF 6 / 23
![Page 64: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/64.jpg)
Proposals of market triggers
Triggers
Flannery (2009): convert if E/RWA x%Hart and Zingales (2010): convert if CDS spread � x bpsPennacchi (2011): convert if CC+E/deposit x%McDonald (2011): convert if ��E � x% and ��(Index) � y%
Where to place a market trigger?
If the bank is expected to experience large losses
the value of financial claims of a bank drops
A CC protects all claims that are senior to it, not junior
junior claims signal the stress more than senior claims
Triggers should be placed on claims junior to CC
the only claim junior to CC is common equity
SW (CU,IU) Contingent Capital JF 6 / 23
![Page 65: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/65.jpg)
Proposals of market triggers
Triggers
Flannery (2009): convert if E/RWA x%Hart and Zingales (2010): convert if CDS spread � x bpsPennacchi (2011): convert if CC+E/deposit x%McDonald (2011): convert if ��E � x% and ��(Index) � y%
Where to place a market trigger?
If the bank is expected to experience large losses
the value of financial claims of a bank drops
A CC protects all claims that are senior to it, not junior
junior claims signal the stress more than senior claims
Triggers should be placed on claims junior to CC
the only claim junior to CC is common equity
SW (CU,IU) Contingent Capital JF 6 / 23
![Page 66: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/66.jpg)
Proposals of market triggers
Triggers
Flannery (2009): convert if E/RWA x%Hart and Zingales (2010): convert if CDS spread � x bpsPennacchi (2011): convert if CC+E/deposit x%McDonald (2011): convert if ��E � x% and ��(Index) � y%
Where to place a market trigger?
If the bank is expected to experience large losses
the value of financial claims of a bank drops
A CC protects all claims that are senior to it, not junior
junior claims signal the stress more than senior claims
Triggers should be placed on claims junior to CC
the only claim junior to CC is common equity
SW (CU,IU) Contingent Capital JF 6 / 23
![Page 67: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/67.jpg)
Proposals of market triggers
Triggers
Flannery (2009): convert if E/RWA x%Hart and Zingales (2010): convert if CDS spread � x bpsPennacchi (2011): convert if CC+E/deposit x%McDonald (2011): convert if ��E � x% and ��(Index) � y%
Where to place a market trigger?
If the bank is expected to experience large losses
the value of financial claims of a bank drops
A CC protects all claims that are senior to it, not junior
junior claims signal the stress more than senior claims
Triggers should be placed on claims junior to CC
the only claim junior to CC is common equity
SW (CU,IU) Contingent Capital JF 6 / 23
![Page 68: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/68.jpg)
Proposals of market triggers
Triggers
Flannery (2009): convert if E/RWA x%Hart and Zingales (2010): convert if CDS spread � x bpsPennacchi (2011): convert if CC+E/deposit x%McDonald (2011): convert if ��E � x% and ��(Index) � y%
Where to place a market trigger?
If the bank is expected to experience large losses
the value of financial claims of a bank drops
A CC protects all claims that are senior to it, not junior
junior claims signal the stress more than senior claims
Triggers should be placed on claims junior to CC
the only claim junior to CC is common equity
SW (CU,IU) Contingent Capital JF 6 / 23
![Page 69: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/69.jpg)
Proposals of market triggers
Triggers
Flannery (2009): convert if E/RWA x%Hart and Zingales (2010): convert if CDS spread � x bpsPennacchi (2011): convert if CC+E/deposit x%McDonald (2011): convert if ��E � x% and ��(Index) � y%
Where to place a market trigger?
If the bank is expected to experience large losses
the value of financial claims of a bank drops
A CC protects all claims that are senior to it, not junior
junior claims signal the stress more than senior claims
Triggers should be placed on claims junior to CC
the only claim junior to CC is common equity
SW (CU,IU) Contingent Capital JF 6 / 23
![Page 70: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/70.jpg)
Proposals of market triggers
Triggers
Flannery (2009): convert if E/RWA x%Hart and Zingales (2010): convert if CDS spread � x bpsPennacchi (2011): convert if CC+E/deposit x%McDonald (2011): convert if ��E � x% and ��(Index) � y%
Where to place a market trigger?
If the bank is expected to experience large losses
the value of financial claims of a bank drops
A CC protects all claims that are senior to it, not junior
junior claims signal the stress more than senior claims
Triggers should be placed on claims junior to CC
the only claim junior to CC is common equity
SW (CU,IU) Contingent Capital JF 6 / 23
![Page 71: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/71.jpg)
Proposals of market triggers
Triggers
Flannery (2009): convert if E/RWA x%Hart and Zingales (2010): convert if CDS spread � x bpsPennacchi (2011): convert if CC+E/deposit x%McDonald (2011): convert if ��E � x% and ��(Index) � y%
Where to place a market trigger?
If the bank is expected to experience large losses
the value of financial claims of a bank drops
A CC protects all claims that are senior to it, not junior
junior claims signal the stress more than senior claims
Triggers should be placed on claims junior to CC
the only claim junior to CC is common equity
SW (CU,IU) Contingent Capital JF 6 / 23
![Page 72: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/72.jpg)
A simplified term sheet
Issuer: systemically-important financial institutions (SIFI)
Security: preferred equity or debt convertible to common equity
Maturity: [10] years, bullet fixed rate
Trigger: market value of equity falls to [4%] of RWA or lower
trigger price: k = 4% ⇥ RWA / shares outstanding
Conversion: full principal converts to equity at price [P]
conversion ratio: m = principal/P
Transferability: no restriction
Regulatory treatment: may not qualify tier 1
but counts towards the supervisory bu↵er
Coupon: [?%] (need to price CC at its par value.)
Secondary market: fair price of CC for given coupon rate
SW (CU,IU) Contingent Capital JF 7 / 23
![Page 73: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/73.jpg)
A simplified term sheet
Issuer: systemically-important financial institutions (SIFI)
Security: preferred equity or debt convertible to common equity
Maturity: [10] years, bullet fixed rate
Trigger: market value of equity falls to [4%] of RWA or lower
trigger price: k = 4% ⇥ RWA / shares outstanding
Conversion: full principal converts to equity at price [P]
conversion ratio: m = principal/P
Transferability: no restriction
Regulatory treatment: may not qualify tier 1
but counts towards the supervisory bu↵er
Coupon: [?%] (need to price CC at its par value.)
Secondary market: fair price of CC for given coupon rate
SW (CU,IU) Contingent Capital JF 7 / 23
![Page 74: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/74.jpg)
A simplified term sheet
Issuer: systemically-important financial institutions (SIFI)
Security: preferred equity or debt convertible to common equity
Maturity: [10] years, bullet fixed rate
Trigger: market value of equity falls to [4%] of RWA or lower
trigger price: k = 4% ⇥ RWA / shares outstanding
Conversion: full principal converts to equity at price [P]
conversion ratio: m = principal/P
Transferability: no restriction
Regulatory treatment: may not qualify tier 1
but counts towards the supervisory bu↵er
Coupon: [?%] (need to price CC at its par value.)
Secondary market: fair price of CC for given coupon rate
SW (CU,IU) Contingent Capital JF 7 / 23
![Page 75: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/75.jpg)
A simplified term sheet
Issuer: systemically-important financial institutions (SIFI)
Security: preferred equity or debt convertible to common equity
Maturity: [10] years, bullet fixed rate
Trigger: market value of equity falls to [4%] of RWA or lower
trigger price: k = 4% ⇥ RWA / shares outstanding
Conversion: full principal converts to equity at price [P]
conversion ratio: m = principal/P
Transferability: no restriction
Regulatory treatment: may not qualify tier 1
but counts towards the supervisory bu↵er
Coupon: [?%] (need to price CC at its par value.)
Secondary market: fair price of CC for given coupon rate
SW (CU,IU) Contingent Capital JF 7 / 23
![Page 76: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/76.jpg)
A simplified term sheet
Issuer: systemically-important financial institutions (SIFI)
Security: preferred equity or debt convertible to common equity
Maturity: [10] years, bullet fixed rate
Trigger: market value of equity falls to [4%] of RWA or lower
trigger price: k = 4% ⇥ RWA / shares outstanding
Conversion: full principal converts to equity at price [P]
conversion ratio: m = principal/P
Transferability: no restriction
Regulatory treatment: may not qualify tier 1
but counts towards the supervisory bu↵er
Coupon: [?%] (need to price CC at its par value.)
Secondary market: fair price of CC for given coupon rate
SW (CU,IU) Contingent Capital JF 7 / 23
![Page 77: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/77.jpg)
A simplified term sheet
Issuer: systemically-important financial institutions (SIFI)
Security: preferred equity or debt convertible to common equity
Maturity: [10] years, bullet fixed rate
Trigger: market value of equity falls to [4%] of RWA or lower
trigger price: k = 4% ⇥ RWA / shares outstanding
Conversion: full principal converts to equity at price [P]
conversion ratio: m = principal/P
Transferability: no restriction
Regulatory treatment: may not qualify tier 1
but counts towards the supervisory bu↵er
Coupon: [?%] (need to price CC at its par value.)
Secondary market: fair price of CC for given coupon rate
SW (CU,IU) Contingent Capital JF 7 / 23
![Page 78: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/78.jpg)
A simplified term sheet
Issuer: systemically-important financial institutions (SIFI)
Security: preferred equity or debt convertible to common equity
Maturity: [10] years, bullet fixed rate
Trigger: market value of equity falls to [4%] of RWA or lower
trigger price: k = 4% ⇥ RWA / shares outstanding
Conversion: full principal converts to equity at price [P]
conversion ratio: m = principal/P
Transferability: no restriction
Regulatory treatment: may not qualify tier 1
but counts towards the supervisory bu↵er
Coupon: [?%] (need to price CC at its par value.)
Secondary market: fair price of CC for given coupon rate
SW (CU,IU) Contingent Capital JF 7 / 23
![Page 79: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/79.jpg)
A simplified term sheet
Issuer: systemically-important financial institutions (SIFI)
Security: preferred equity or debt convertible to common equity
Maturity: [10] years, bullet fixed rate
Trigger: market value of equity falls to [4%] of RWA or lower
trigger price: k = 4% ⇥ RWA / shares outstanding
Conversion: full principal converts to equity at price [P]
conversion ratio: m = principal/P
Transferability: no restriction
Regulatory treatment: may not qualify tier 1
but counts towards the supervisory bu↵er
Coupon: [?%] (need to price CC at its par value.)
Secondary market: fair price of CC for given coupon rate
SW (CU,IU) Contingent Capital JF 7 / 23
![Page 80: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/80.jpg)
A simplified term sheet
Issuer: systemically-important financial institutions (SIFI)
Security: preferred equity or debt convertible to common equity
Maturity: [10] years, bullet fixed rate
Trigger: market value of equity falls to [4%] of RWA or lower
trigger price: k = 4% ⇥ RWA / shares outstanding
Conversion: full principal converts to equity at price [P]
conversion ratio: m = principal/P
Transferability: no restriction
Regulatory treatment: may not qualify tier 1
but counts towards the supervisory bu↵er
Coupon: [?%] (need to price CC at its par value.)
Secondary market: fair price of CC for given coupon rate
SW (CU,IU) Contingent Capital JF 7 / 23
![Page 81: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/81.jpg)
A simplified term sheet
Issuer: systemically-important financial institutions (SIFI)
Security: preferred equity or debt convertible to common equity
Maturity: [10] years, bullet fixed rate
Trigger: market value of equity falls to [4%] of RWA or lower
trigger price: k = 4% ⇥ RWA / shares outstanding
Conversion: full principal converts to equity at price [P]
conversion ratio: m = principal/P
Transferability: no restriction
Regulatory treatment: may not qualify tier 1
but counts towards the supervisory bu↵er
Coupon: [?%] (need to price CC at its par value.)
Secondary market: fair price of CC for given coupon rate
SW (CU,IU) Contingent Capital JF 7 / 23
![Page 82: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/82.jpg)
Example: a simple firm with CC
Risky asset
can have value A (e.g., 106, 104, or 80)
Senior bond
par value: B = 90 about to mature now
Contingent capital
par value: C = 10 about to mature nowmandatory conversion trigger: K = 5conversion ratio: m =? (will try various numbers)
Common equity, n shares: (n = 1)
If not converted: S = (A� B � C )/nIf converted: S = (A� B)/(n +m)If bankrupt: S = 0
SW (CU,IU) Contingent Capital JF 8 / 23
![Page 83: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/83.jpg)
Example: a simple firm with CC
Risky asset
can have value A (e.g., 106, 104, or 80)
Senior bond
par value: B = 90 about to mature now
Contingent capital
par value: C = 10 about to mature nowmandatory conversion trigger: K = 5conversion ratio: m =? (will try various numbers)
Common equity, n shares: (n = 1)
If not converted: S = (A� B � C )/nIf converted: S = (A� B)/(n +m)If bankrupt: S = 0
SW (CU,IU) Contingent Capital JF 8 / 23
![Page 84: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/84.jpg)
Example: a simple firm with CC
Risky asset
can have value A (e.g., 106, 104, or 80)
Senior bond
par value: B = 90 about to mature now
Contingent capital
par value: C = 10 about to mature nowmandatory conversion trigger: K = 5conversion ratio: m =? (will try various numbers)
Common equity, n shares: (n = 1)
If not converted: S = (A� B � C )/nIf converted: S = (A� B)/(n +m)If bankrupt: S = 0
SW (CU,IU) Contingent Capital JF 8 / 23
![Page 85: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/85.jpg)
Example: a simple firm with CC
Risky asset
can have value A (e.g., 106, 104, or 80)
Senior bond
par value: B = 90 about to mature now
Contingent capital
par value: C = 10 about to mature nowmandatory conversion trigger: K = 5conversion ratio: m =? (will try various numbers)
Common equity, n shares: (n = 1)
If not converted: S = (A� B � C )/nIf converted: S = (A� B)/(n +m)If bankrupt: S = 0
SW (CU,IU) Contingent Capital JF 8 / 23
![Page 86: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/86.jpg)
Example: a simple firm with CC
Risky asset
can have value A (e.g., 106, 104, or 80)
Senior bond
par value: B = 90 about to mature now
Contingent capital
par value: C = 10 about to mature nowmandatory conversion trigger: K = 5conversion ratio: m =? (will try various numbers)
Common equity, n shares: (n = 1)
If not converted: S = (A� B � C )/nIf converted: S = (A� B)/(n +m)If bankrupt: S = 0
SW (CU,IU) Contingent Capital JF 8 / 23
![Page 87: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/87.jpg)
Example: a simple firm with CC
Risky asset
can have value A (e.g., 106, 104, or 80)
Senior bond
par value: B = 90 about to mature now
Contingent capital
par value: C = 10 about to mature nowmandatory conversion trigger: K = 5conversion ratio: m =? (will try various numbers)
Common equity, n shares: (n = 1)
If not converted: S = (A� B � C )/nIf converted: S = (A� B)/(n +m)If bankrupt: S = 0
SW (CU,IU) Contingent Capital JF 8 / 23
![Page 88: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/88.jpg)
Example: a simple firm with CC
Risky asset
can have value A (e.g., 106, 104, or 80)
Senior bond
par value: B = 90 about to mature now
Contingent capital
par value: C = 10 about to mature now
mandatory conversion trigger: K = 5conversion ratio: m =? (will try various numbers)
Common equity, n shares: (n = 1)
If not converted: S = (A� B � C )/nIf converted: S = (A� B)/(n +m)If bankrupt: S = 0
SW (CU,IU) Contingent Capital JF 8 / 23
![Page 89: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/89.jpg)
Example: a simple firm with CC
Risky asset
can have value A (e.g., 106, 104, or 80)
Senior bond
par value: B = 90 about to mature now
Contingent capital
par value: C = 10 about to mature nowmandatory conversion trigger: K = 5
conversion ratio: m =? (will try various numbers)
Common equity, n shares: (n = 1)
If not converted: S = (A� B � C )/nIf converted: S = (A� B)/(n +m)If bankrupt: S = 0
SW (CU,IU) Contingent Capital JF 8 / 23
![Page 90: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/90.jpg)
Example: a simple firm with CC
Risky asset
can have value A (e.g., 106, 104, or 80)
Senior bond
par value: B = 90 about to mature now
Contingent capital
par value: C = 10 about to mature nowmandatory conversion trigger: K = 5conversion ratio: m =? (will try various numbers)
Common equity, n shares: (n = 1)
If not converted: S = (A� B � C )/nIf converted: S = (A� B)/(n +m)If bankrupt: S = 0
SW (CU,IU) Contingent Capital JF 8 / 23
![Page 91: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/91.jpg)
Example: a simple firm with CC
Risky asset
can have value A (e.g., 106, 104, or 80)
Senior bond
par value: B = 90 about to mature now
Contingent capital
par value: C = 10 about to mature nowmandatory conversion trigger: K = 5conversion ratio: m =? (will try various numbers)
Common equity, n shares: (n = 1)
If not converted: S = (A� B � C )/nIf converted: S = (A� B)/(n +m)If bankrupt: S = 0
SW (CU,IU) Contingent Capital JF 8 / 23
![Page 92: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/92.jpg)
Example: a simple firm with CC
Risky asset
can have value A (e.g., 106, 104, or 80)
Senior bond
par value: B = 90 about to mature now
Contingent capital
par value: C = 10 about to mature nowmandatory conversion trigger: K = 5conversion ratio: m =? (will try various numbers)
Common equity, n shares: (n = 1)
If not converted: S = (A� B � C )/n
If converted: S = (A� B)/(n +m)If bankrupt: S = 0
SW (CU,IU) Contingent Capital JF 8 / 23
![Page 93: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/93.jpg)
Example: a simple firm with CC
Risky asset
can have value A (e.g., 106, 104, or 80)
Senior bond
par value: B = 90 about to mature now
Contingent capital
par value: C = 10 about to mature nowmandatory conversion trigger: K = 5conversion ratio: m =? (will try various numbers)
Common equity, n shares: (n = 1)
If not converted: S = (A� B � C )/nIf converted: S = (A� B)/(n +m)
If bankrupt: S = 0
SW (CU,IU) Contingent Capital JF 8 / 23
![Page 94: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/94.jpg)
Example: a simple firm with CC
Risky asset
can have value A (e.g., 106, 104, or 80)
Senior bond
par value: B = 90 about to mature now
Contingent capital
par value: C = 10 about to mature nowmandatory conversion trigger: K = 5conversion ratio: m =? (will try various numbers)
Common equity, n shares: (n = 1)
If not converted: S = (A� B � C )/nIf converted: S = (A� B)/(n +m)If bankrupt: S = 0
SW (CU,IU) Contingent Capital JF 8 / 23
![Page 95: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/95.jpg)
If conversion ratio is too high or too low
Suppose m = 3. When the asset value turns out to be 106
If investors believe CC will not convert
S = (106� 90� 10)/1 = 6 > K , C = par value = 10
If investors believe CC will convert
S = (106� 90)/(1 + 3) = 4 < K , C = 3⇥ 4 = 12
Two pairs of rational stock price and CC value
Suppose m = 1. When the asset value turns out to be 104
If investors believe CC will not convert
S = (104� 90� 10)/1 = 4 < K , C = 10
If investors believe CC will convert
S = (104� 90)/(1 + 1) = 7 > K , C = 1⇥ 7 = 7
No pair of stock price and CC value is rational
SW (CU,IU) Contingent Capital JF 9 / 23
![Page 96: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/96.jpg)
If conversion ratio is too high or too low
Suppose m = 3. When the asset value turns out to be 106
If investors believe CC will not convert
S = (106� 90� 10)/1 = 6 > K , C = par value = 10
If investors believe CC will convert
S = (106� 90)/(1 + 3) = 4 < K , C = 3⇥ 4 = 12
Two pairs of rational stock price and CC value
Suppose m = 1. When the asset value turns out to be 104
If investors believe CC will not convert
S = (104� 90� 10)/1 = 4 < K , C = 10
If investors believe CC will convert
S = (104� 90)/(1 + 1) = 7 > K , C = 1⇥ 7 = 7
No pair of stock price and CC value is rational
SW (CU,IU) Contingent Capital JF 9 / 23
![Page 97: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/97.jpg)
If conversion ratio is too high or too low
Suppose m = 3. When the asset value turns out to be 106
If investors believe CC will not convert
S = (106� 90� 10)/1 = 6 > K , C = par value = 10
If investors believe CC will convert
S = (106� 90)/(1 + 3) = 4 < K , C = 3⇥ 4 = 12
Two pairs of rational stock price and CC value
Suppose m = 1. When the asset value turns out to be 104
If investors believe CC will not convert
S = (104� 90� 10)/1 = 4 < K , C = 10
If investors believe CC will convert
S = (104� 90)/(1 + 1) = 7 > K , C = 1⇥ 7 = 7
No pair of stock price and CC value is rational
SW (CU,IU) Contingent Capital JF 9 / 23
![Page 98: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/98.jpg)
If conversion ratio is too high or too low
Suppose m = 3. When the asset value turns out to be 106
If investors believe CC will not convert
S = (106� 90� 10)/1 = 6 > K , C = par value = 10
If investors believe CC will convert
S = (106� 90)/(1 + 3) = 4 < K , C = 3⇥ 4 = 12
Two pairs of rational stock price and CC value
Suppose m = 1. When the asset value turns out to be 104
If investors believe CC will not convert
S = (104� 90� 10)/1 = 4 < K , C = 10
If investors believe CC will convert
S = (104� 90)/(1 + 1) = 7 > K , C = 1⇥ 7 = 7
No pair of stock price and CC value is rational
SW (CU,IU) Contingent Capital JF 9 / 23
![Page 99: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/99.jpg)
If conversion ratio is too high or too low
Suppose m = 3. When the asset value turns out to be 106
If investors believe CC will not convert
S = (106� 90� 10)/1 = 6 > K , C = par value = 10
If investors believe CC will convert
S = (106� 90)/(1 + 3) = 4 < K , C = 3⇥ 4 = 12
Two pairs of rational stock price and CC value
Suppose m = 1. When the asset value turns out to be 104
If investors believe CC will not convert
S = (104� 90� 10)/1 = 4 < K , C = 10
If investors believe CC will convert
S = (104� 90)/(1 + 1) = 7 > K , C = 1⇥ 7 = 7
No pair of stock price and CC value is rational
SW (CU,IU) Contingent Capital JF 9 / 23
![Page 100: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/100.jpg)
If conversion ratio is too high or too low
Suppose m = 3. When the asset value turns out to be 106
If investors believe CC will not convert
S = (106� 90� 10)/1 = 6 > K , C = par value = 10
If investors believe CC will convert
S = (106� 90)/(1 + 3) = 4 < K , C = 3⇥ 4 = 12
Two pairs of rational stock price and CC value
Suppose m = 1. When the asset value turns out to be 104
If investors believe CC will not convert
S = (104� 90� 10)/1 = 4 < K , C = 10
If investors believe CC will convert
S = (104� 90)/(1 + 1) = 7 > K , C = 1⇥ 7 = 7
No pair of stock price and CC value is rational
SW (CU,IU) Contingent Capital JF 9 / 23
![Page 101: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/101.jpg)
If conversion ratio is too high or too low
Suppose m = 3. When the asset value turns out to be 106
If investors believe CC will not convert
S = (106� 90� 10)/1 = 6 > K , C = par value = 10
If investors believe CC will convert
S = (106� 90)/(1 + 3) = 4 < K , C = 3⇥ 4 = 12
Two pairs of rational stock price and CC value
Suppose m = 1. When the asset value turns out to be 104
If investors believe CC will not convert
S = (104� 90� 10)/1 = 4 < K , C = 10
If investors believe CC will convert
S = (104� 90)/(1 + 1) = 7 > K , C = 1⇥ 7 = 7
No pair of stock price and CC value is rational
SW (CU,IU) Contingent Capital JF 9 / 23
![Page 102: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/102.jpg)
If conversion ratio is too high or too low
Suppose m = 3. When the asset value turns out to be 106
If investors believe CC will not convert
S = (106� 90� 10)/1 = 6 > K , C = par value = 10
If investors believe CC will convert
S = (106� 90)/(1 + 3) = 4 < K , C = 3⇥ 4 = 12
Two pairs of rational stock price and CC value
Suppose m = 1. When the asset value turns out to be 104
If investors believe CC will not convert
S = (104� 90� 10)/1 = 4 < K , C = 10
If investors believe CC will convert
S = (104� 90)/(1 + 1) = 7 > K , C = 1⇥ 7 = 7
No pair of stock price and CC value is rational
SW (CU,IU) Contingent Capital JF 9 / 23
![Page 103: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/103.jpg)
If conversion ratio is too high or too low
Suppose m = 3. When the asset value turns out to be 106
If investors believe CC will not convert
S = (106� 90� 10)/1 = 6 > K , C = par value = 10
If investors believe CC will convert
S = (106� 90)/(1 + 3) = 4 < K , C = 3⇥ 4 = 12
Two pairs of rational stock price and CC value
Suppose m = 1. When the asset value turns out to be 104
If investors believe CC will not convert
S = (104� 90� 10)/1 = 4 < K , C = 10
If investors believe CC will convert
S = (104� 90)/(1 + 1) = 7 > K , C = 1⇥ 7 = 7
No pair of stock price and CC value is rational
SW (CU,IU) Contingent Capital JF 9 / 23
![Page 104: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/104.jpg)
If conversion ratio is too high or too low
Suppose m = 3. When the asset value turns out to be 106
If investors believe CC will not convert
S = (106� 90� 10)/1 = 6 > K , C = par value = 10
If investors believe CC will convert
S = (106� 90)/(1 + 3) = 4 < K , C = 3⇥ 4 = 12
Two pairs of rational stock price and CC value
Suppose m = 1. When the asset value turns out to be 104
If investors believe CC will not convert
S = (104� 90� 10)/1 = 4 < K , C = 10
If investors believe CC will convert
S = (104� 90)/(1 + 1) = 7 > K , C = 1⇥ 7 = 7
No pair of stock price and CC value is rational
SW (CU,IU) Contingent Capital JF 9 / 23
![Page 105: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/105.jpg)
If conversion ratio is too high or too low
Suppose m = 3. When the asset value turns out to be 106
If investors believe CC will not convert
S = (106� 90� 10)/1 = 6 > K , C = par value = 10
If investors believe CC will convert
S = (106� 90)/(1 + 3) = 4 < K , C = 3⇥ 4 = 12
Two pairs of rational stock price and CC value
Suppose m = 1. When the asset value turns out to be 104
If investors believe CC will not convert
S = (104� 90� 10)/1 = 4 < K , C = 10
If investors believe CC will convert
S = (104� 90)/(1 + 1) = 7 > K , C = 1⇥ 7 = 7
No pair of stock price and CC value is rational
SW (CU,IU) Contingent Capital JF 9 / 23
![Page 106: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/106.jpg)
If conversion ratio is too high or too low
Suppose m = 3. When the asset value turns out to be 106
If investors believe CC will not convert
S = (106� 90� 10)/1 = 6 > K , C = par value = 10
If investors believe CC will convert
S = (106� 90)/(1 + 3) = 4 < K , C = 3⇥ 4 = 12
Two pairs of rational stock price and CC value
Suppose m = 1. When the asset value turns out to be 104
If investors believe CC will not convert
S = (104� 90� 10)/1 = 4 < K , C = 10
If investors believe CC will convert
S = (104� 90)/(1 + 1) = 7 > K , C = 1⇥ 7 = 7
No pair of stock price and CC value is rational
SW (CU,IU) Contingent Capital JF 9 / 23
![Page 107: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/107.jpg)
If conversion ratio is too high or too low
Suppose m = 3. When the asset value turns out to be 106
If investors believe CC will not convert
S = (106� 90� 10)/1 = 6 > K , C = par value = 10
If investors believe CC will convert
S = (106� 90)/(1 + 3) = 4 < K , C = 3⇥ 4 = 12
Two pairs of rational stock price and CC value
Suppose m = 1. When the asset value turns out to be 104
If investors believe CC will not convert
S = (104� 90� 10)/1 = 4 < K , C = 10
If investors believe CC will convert
S = (104� 90)/(1 + 1) = 7 > K , C = 1⇥ 7 = 7
No pair of stock price and CC value is rational
SW (CU,IU) Contingent Capital JF 9 / 23
![Page 108: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/108.jpg)
If conversion ratio is just right: m = 2
In case asset value = 104
No conversion: S = (104� 90� 10)/1 = 4 < K
Conversion: S = (104� 90)/(1 + 2) = 4.66 < K
CC is expected to convert; stock price is 4.66
In case asset value = 106
No conversion: S = (106� 90� 10)/1 = 6 > K
Conversion: S = (106� 90)/(1 + 2) = 5.33 > K
CC is expected not to convert; stock price is 6
m = 2 guarantees a unique equilibrium
no ambiguity about conversion for all Amarket settles to a unique equilibrium
Only m = 2 guarantees a unique equilibrium
m = 2 = C/(K/n) = 10/(5/1) = 2Otherwise, payo↵ function is not well-defined or measurable
SW (CU,IU) Contingent Capital JF 10 / 23
![Page 109: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/109.jpg)
If conversion ratio is just right: m = 2
In case asset value = 104
No conversion: S = (104� 90� 10)/1 = 4 < K
Conversion: S = (104� 90)/(1 + 2) = 4.66 < K
CC is expected to convert; stock price is 4.66
In case asset value = 106
No conversion: S = (106� 90� 10)/1 = 6 > K
Conversion: S = (106� 90)/(1 + 2) = 5.33 > K
CC is expected not to convert; stock price is 6
m = 2 guarantees a unique equilibrium
no ambiguity about conversion for all Amarket settles to a unique equilibrium
Only m = 2 guarantees a unique equilibrium
m = 2 = C/(K/n) = 10/(5/1) = 2Otherwise, payo↵ function is not well-defined or measurable
SW (CU,IU) Contingent Capital JF 10 / 23
![Page 110: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/110.jpg)
If conversion ratio is just right: m = 2
In case asset value = 104
No conversion: S = (104� 90� 10)/1 = 4 < K
Conversion: S = (104� 90)/(1 + 2) = 4.66 < K
CC is expected to convert; stock price is 4.66
In case asset value = 106
No conversion: S = (106� 90� 10)/1 = 6 > K
Conversion: S = (106� 90)/(1 + 2) = 5.33 > K
CC is expected not to convert; stock price is 6
m = 2 guarantees a unique equilibrium
no ambiguity about conversion for all Amarket settles to a unique equilibrium
Only m = 2 guarantees a unique equilibrium
m = 2 = C/(K/n) = 10/(5/1) = 2Otherwise, payo↵ function is not well-defined or measurable
SW (CU,IU) Contingent Capital JF 10 / 23
![Page 111: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/111.jpg)
If conversion ratio is just right: m = 2
In case asset value = 104
No conversion: S = (104� 90� 10)/1 = 4 < K
Conversion: S = (104� 90)/(1 + 2) = 4.66 < K
CC is expected to convert; stock price is 4.66
In case asset value = 106
No conversion: S = (106� 90� 10)/1 = 6 > K
Conversion: S = (106� 90)/(1 + 2) = 5.33 > K
CC is expected not to convert; stock price is 6
m = 2 guarantees a unique equilibrium
no ambiguity about conversion for all Amarket settles to a unique equilibrium
Only m = 2 guarantees a unique equilibrium
m = 2 = C/(K/n) = 10/(5/1) = 2Otherwise, payo↵ function is not well-defined or measurable
SW (CU,IU) Contingent Capital JF 10 / 23
![Page 112: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/112.jpg)
If conversion ratio is just right: m = 2
In case asset value = 104
No conversion: S = (104� 90� 10)/1 = 4 < K
Conversion: S = (104� 90)/(1 + 2) = 4.66 < K
CC is expected to convert; stock price is 4.66
In case asset value = 106
No conversion: S = (106� 90� 10)/1 = 6 > K
Conversion: S = (106� 90)/(1 + 2) = 5.33 > K
CC is expected not to convert; stock price is 6
m = 2 guarantees a unique equilibrium
no ambiguity about conversion for all Amarket settles to a unique equilibrium
Only m = 2 guarantees a unique equilibrium
m = 2 = C/(K/n) = 10/(5/1) = 2Otherwise, payo↵ function is not well-defined or measurable
SW (CU,IU) Contingent Capital JF 10 / 23
![Page 113: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/113.jpg)
If conversion ratio is just right: m = 2
In case asset value = 104
No conversion: S = (104� 90� 10)/1 = 4 < K
Conversion: S = (104� 90)/(1 + 2) = 4.66 < K
CC is expected to convert; stock price is 4.66
In case asset value = 106
No conversion: S = (106� 90� 10)/1 = 6 > K
Conversion: S = (106� 90)/(1 + 2) = 5.33 > K
CC is expected not to convert; stock price is 6
m = 2 guarantees a unique equilibrium
no ambiguity about conversion for all Amarket settles to a unique equilibrium
Only m = 2 guarantees a unique equilibrium
m = 2 = C/(K/n) = 10/(5/1) = 2Otherwise, payo↵ function is not well-defined or measurable
SW (CU,IU) Contingent Capital JF 10 / 23
![Page 114: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/114.jpg)
If conversion ratio is just right: m = 2
In case asset value = 104
No conversion: S = (104� 90� 10)/1 = 4 < K
Conversion: S = (104� 90)/(1 + 2) = 4.66 < K
CC is expected to convert; stock price is 4.66
In case asset value = 106
No conversion: S = (106� 90� 10)/1 = 6 > K
Conversion: S = (106� 90)/(1 + 2) = 5.33 > K
CC is expected not to convert; stock price is 6
m = 2 guarantees a unique equilibrium
no ambiguity about conversion for all Amarket settles to a unique equilibrium
Only m = 2 guarantees a unique equilibrium
m = 2 = C/(K/n) = 10/(5/1) = 2Otherwise, payo↵ function is not well-defined or measurable
SW (CU,IU) Contingent Capital JF 10 / 23
![Page 115: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/115.jpg)
If conversion ratio is just right: m = 2
In case asset value = 104
No conversion: S = (104� 90� 10)/1 = 4 < K
Conversion: S = (104� 90)/(1 + 2) = 4.66 < K
CC is expected to convert; stock price is 4.66
In case asset value = 106
No conversion: S = (106� 90� 10)/1 = 6 > K
Conversion: S = (106� 90)/(1 + 2) = 5.33 > K
CC is expected not to convert; stock price is 6
m = 2 guarantees a unique equilibrium
no ambiguity about conversion for all Amarket settles to a unique equilibrium
Only m = 2 guarantees a unique equilibrium
m = 2 = C/(K/n) = 10/(5/1) = 2Otherwise, payo↵ function is not well-defined or measurable
SW (CU,IU) Contingent Capital JF 10 / 23
![Page 116: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/116.jpg)
If conversion ratio is just right: m = 2
In case asset value = 104
No conversion: S = (104� 90� 10)/1 = 4 < K
Conversion: S = (104� 90)/(1 + 2) = 4.66 < K
CC is expected to convert; stock price is 4.66
In case asset value = 106
No conversion: S = (106� 90� 10)/1 = 6 > K
Conversion: S = (106� 90)/(1 + 2) = 5.33 > K
CC is expected not to convert; stock price is 6
m = 2 guarantees a unique equilibrium
no ambiguity about conversion for all Amarket settles to a unique equilibrium
Only m = 2 guarantees a unique equilibrium
m = 2 = C/(K/n) = 10/(5/1) = 2Otherwise, payo↵ function is not well-defined or measurable
SW (CU,IU) Contingent Capital JF 10 / 23
![Page 117: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/117.jpg)
If conversion ratio is just right: m = 2
In case asset value = 104
No conversion: S = (104� 90� 10)/1 = 4 < K
Conversion: S = (104� 90)/(1 + 2) = 4.66 < K
CC is expected to convert; stock price is 4.66
In case asset value = 106
No conversion: S = (106� 90� 10)/1 = 6 > K
Conversion: S = (106� 90)/(1 + 2) = 5.33 > K
CC is expected not to convert; stock price is 6
m = 2 guarantees a unique equilibrium
no ambiguity about conversion for all Amarket settles to a unique equilibrium
Only m = 2 guarantees a unique equilibrium
m = 2 = C/(K/n) = 10/(5/1) = 2Otherwise, payo↵ function is not well-defined or measurable
SW (CU,IU) Contingent Capital JF 10 / 23
![Page 118: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/118.jpg)
If conversion ratio is just right: m = 2
In case asset value = 104
No conversion: S = (104� 90� 10)/1 = 4 < K
Conversion: S = (104� 90)/(1 + 2) = 4.66 < K
CC is expected to convert; stock price is 4.66
In case asset value = 106
No conversion: S = (106� 90� 10)/1 = 6 > K
Conversion: S = (106� 90)/(1 + 2) = 5.33 > K
CC is expected not to convert; stock price is 6
m = 2 guarantees a unique equilibrium
no ambiguity about conversion for all A
market settles to a unique equilibrium
Only m = 2 guarantees a unique equilibrium
m = 2 = C/(K/n) = 10/(5/1) = 2Otherwise, payo↵ function is not well-defined or measurable
SW (CU,IU) Contingent Capital JF 10 / 23
![Page 119: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/119.jpg)
If conversion ratio is just right: m = 2
In case asset value = 104
No conversion: S = (104� 90� 10)/1 = 4 < K
Conversion: S = (104� 90)/(1 + 2) = 4.66 < K
CC is expected to convert; stock price is 4.66
In case asset value = 106
No conversion: S = (106� 90� 10)/1 = 6 > K
Conversion: S = (106� 90)/(1 + 2) = 5.33 > K
CC is expected not to convert; stock price is 6
m = 2 guarantees a unique equilibrium
no ambiguity about conversion for all Amarket settles to a unique equilibrium
Only m = 2 guarantees a unique equilibrium
m = 2 = C/(K/n) = 10/(5/1) = 2Otherwise, payo↵ function is not well-defined or measurable
SW (CU,IU) Contingent Capital JF 10 / 23
![Page 120: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/120.jpg)
If conversion ratio is just right: m = 2
In case asset value = 104
No conversion: S = (104� 90� 10)/1 = 4 < K
Conversion: S = (104� 90)/(1 + 2) = 4.66 < K
CC is expected to convert; stock price is 4.66
In case asset value = 106
No conversion: S = (106� 90� 10)/1 = 6 > K
Conversion: S = (106� 90)/(1 + 2) = 5.33 > K
CC is expected not to convert; stock price is 6
m = 2 guarantees a unique equilibrium
no ambiguity about conversion for all Amarket settles to a unique equilibrium
Only m = 2 guarantees a unique equilibrium
m = 2 = C/(K/n) = 10/(5/1) = 2Otherwise, payo↵ function is not well-defined or measurable
SW (CU,IU) Contingent Capital JF 10 / 23
![Page 121: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/121.jpg)
If conversion ratio is just right: m = 2
In case asset value = 104
No conversion: S = (104� 90� 10)/1 = 4 < K
Conversion: S = (104� 90)/(1 + 2) = 4.66 < K
CC is expected to convert; stock price is 4.66
In case asset value = 106
No conversion: S = (106� 90� 10)/1 = 6 > K
Conversion: S = (106� 90)/(1 + 2) = 5.33 > K
CC is expected not to convert; stock price is 6
m = 2 guarantees a unique equilibrium
no ambiguity about conversion for all Amarket settles to a unique equilibrium
Only m = 2 guarantees a unique equilibrium
m = 2 = C/(K/n) = 10/(5/1) = 2
Otherwise, payo↵ function is not well-defined or measurable
SW (CU,IU) Contingent Capital JF 10 / 23
![Page 122: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/122.jpg)
If conversion ratio is just right: m = 2
In case asset value = 104
No conversion: S = (104� 90� 10)/1 = 4 < K
Conversion: S = (104� 90)/(1 + 2) = 4.66 < K
CC is expected to convert; stock price is 4.66
In case asset value = 106
No conversion: S = (106� 90� 10)/1 = 6 > K
Conversion: S = (106� 90)/(1 + 2) = 5.33 > K
CC is expected not to convert; stock price is 6
m = 2 guarantees a unique equilibrium
no ambiguity about conversion for all Amarket settles to a unique equilibrium
Only m = 2 guarantees a unique equilibrium
m = 2 = C/(K/n) = 10/(5/1) = 2Otherwise, payo↵ function is not well-defined or measurable
SW (CU,IU) Contingent Capital JF 10 / 23
![Page 123: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/123.jpg)
Pricing before maturity — asset and bond
• m = 2 guarantees a unique equilibrium at maturity
• but it does not guarantee this before maturity
asset t100.00 ⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t120.00 prob = 0.25
t100.00 prob = 0.50XXXXXXXXXXXt 80.00 prob = 0.25
bond r⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t 90.00 no default
t 90.00 no defaultXXXXXXXXXXXt 80.00 default
87.50
SW (CU,IU) Contingent Capital JF 11 / 23
![Page 124: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/124.jpg)
Pricing before maturity — asset and bond
• m = 2 guarantees a unique equilibrium at maturity
• but it does not guarantee this before maturity
asset t100.00 ⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t120.00 prob = 0.25
t100.00 prob = 0.50XXXXXXXXXXXt 80.00 prob = 0.25
bond r⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t 90.00 no default
t 90.00 no defaultXXXXXXXXXXXt 80.00 default
87.50
SW (CU,IU) Contingent Capital JF 11 / 23
![Page 125: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/125.jpg)
Pricing before maturity — asset and bond
• m = 2 guarantees a unique equilibrium at maturity
• but it does not guarantee this before maturity
asset t100.00 ⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t120.00 prob = 0.25
t100.00 prob = 0.50XXXXXXXXXXXt 80.00 prob = 0.25
bond r⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t 90.00 no default
t 90.00 no defaultXXXXXXXXXXXt 80.00 default
87.50
SW (CU,IU) Contingent Capital JF 11 / 23
![Page 126: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/126.jpg)
Pricing before maturity — asset and bond
• m = 2 guarantees a unique equilibrium at maturity
• but it does not guarantee this before maturity
asset t100.00
⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t120.00 prob = 0.25
t100.00 prob = 0.50XXXXXXXXXXXt 80.00 prob = 0.25
bond r⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t 90.00 no default
t 90.00 no defaultXXXXXXXXXXXt 80.00 default
87.50
SW (CU,IU) Contingent Capital JF 11 / 23
![Page 127: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/127.jpg)
Pricing before maturity — asset and bond
• m = 2 guarantees a unique equilibrium at maturity
• but it does not guarantee this before maturity
asset t100.00 ⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t120.00 prob = 0.25
t100.00 prob = 0.50XXXXXXXXXXXt 80.00 prob = 0.25
bond r⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t 90.00 no default
t 90.00 no defaultXXXXXXXXXXXt 80.00 default
87.50
SW (CU,IU) Contingent Capital JF 11 / 23
![Page 128: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/128.jpg)
Pricing before maturity — asset and bond
• m = 2 guarantees a unique equilibrium at maturity
• but it does not guarantee this before maturity
asset t100.00 ⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t120.00 prob = 0.25
t100.00 prob = 0.50
XXXXXXXXXXXt 80.00 prob = 0.25
bond r⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t 90.00 no default
t 90.00 no defaultXXXXXXXXXXXt 80.00 default
87.50
SW (CU,IU) Contingent Capital JF 11 / 23
![Page 129: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/129.jpg)
Pricing before maturity — asset and bond
• m = 2 guarantees a unique equilibrium at maturity
• but it does not guarantee this before maturity
asset t100.00 ⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t120.00 prob = 0.25
t100.00 prob = 0.50XXXXXXXXXXXt 80.00 prob = 0.25
bond r⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t 90.00 no default
t 90.00 no defaultXXXXXXXXXXXt 80.00 default
87.50
SW (CU,IU) Contingent Capital JF 11 / 23
![Page 130: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/130.jpg)
Pricing before maturity — asset and bond
• m = 2 guarantees a unique equilibrium at maturity
• but it does not guarantee this before maturity
asset t100.00 ⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t120.00 prob = 0.25
t100.00 prob = 0.50XXXXXXXXXXXt 80.00 prob = 0.25
bond r
⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t 90.00 no default
t 90.00 no defaultXXXXXXXXXXXt 80.00 default
87.50
SW (CU,IU) Contingent Capital JF 11 / 23
![Page 131: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/131.jpg)
Pricing before maturity — asset and bond
• m = 2 guarantees a unique equilibrium at maturity
• but it does not guarantee this before maturity
asset t100.00 ⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t120.00 prob = 0.25
t100.00 prob = 0.50XXXXXXXXXXXt 80.00 prob = 0.25
bond r⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t 90.00 no default
t 90.00 no defaultXXXXXXXXXXXt 80.00 default
87.50
SW (CU,IU) Contingent Capital JF 11 / 23
![Page 132: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/132.jpg)
Pricing before maturity — asset and bond
• m = 2 guarantees a unique equilibrium at maturity
• but it does not guarantee this before maturity
asset t100.00 ⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t120.00 prob = 0.25
t100.00 prob = 0.50XXXXXXXXXXXt 80.00 prob = 0.25
bond r⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t 90.00 no default
t 90.00 no default
XXXXXXXXXXXt 80.00 default
87.50
SW (CU,IU) Contingent Capital JF 11 / 23
![Page 133: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/133.jpg)
Pricing before maturity — asset and bond
• m = 2 guarantees a unique equilibrium at maturity
• but it does not guarantee this before maturity
asset t100.00 ⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t120.00 prob = 0.25
t100.00 prob = 0.50XXXXXXXXXXXt 80.00 prob = 0.25
bond r⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t 90.00 no default
t 90.00 no defaultXXXXXXXXXXXt 80.00 default
87.50
SW (CU,IU) Contingent Capital JF 11 / 23
![Page 134: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/134.jpg)
Pricing before maturity — asset and bond
• m = 2 guarantees a unique equilibrium at maturity
• but it does not guarantee this before maturity
asset t100.00 ⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t120.00 prob = 0.25
t100.00 prob = 0.50XXXXXXXXXXXt 80.00 prob = 0.25
bond r⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t 90.00 no default
t 90.00 no defaultXXXXXXXXXXXt 80.00 default
87.50
SW (CU,IU) Contingent Capital JF 11 / 23
![Page 135: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/135.jpg)
Pricing before maturity — CC and equity
Equilibrium 1: late conversion
tCoCo:
tEquity:
⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t10.00 no conversion
⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t20.00 = (120� 90� 10)/1
t 6.67 convert to 2 shares
t 3.33 = (100� 90)/(1 + 2)
XXXXXXXXXXXt 0.00 firm defaults
XXXXXXXXXXXt 0.00 firm defaults
C = 5.83
S = 6.67
Equilibrium 2: early conversiontCoCo: tEquity:
= 2(100� 87.50)/(1 + 2)
= 1(100� 87.50)/(1 + 2)C = 8.33
S = 4.17
SW (CU,IU) Contingent Capital JF 12 / 23
![Page 136: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/136.jpg)
Pricing before maturity — CC and equityEquilibrium 1: late conversion
tCoCo:
tEquity:
⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t10.00 no conversion
⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t20.00 = (120� 90� 10)/1
t 6.67 convert to 2 shares
t 3.33 = (100� 90)/(1 + 2)
XXXXXXXXXXXt 0.00 firm defaults
XXXXXXXXXXXt 0.00 firm defaults
C = 5.83
S = 6.67
Equilibrium 2: early conversiontCoCo: tEquity:
= 2(100� 87.50)/(1 + 2)
= 1(100� 87.50)/(1 + 2)C = 8.33
S = 4.17
SW (CU,IU) Contingent Capital JF 12 / 23
![Page 137: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/137.jpg)
Pricing before maturity — CC and equityEquilibrium 1: late conversion
tCoCo:
tEquity:
⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t10.00 no conversion
⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t20.00 = (120� 90� 10)/1
t 6.67 convert to 2 shares
t 3.33 = (100� 90)/(1 + 2)
XXXXXXXXXXXt 0.00 firm defaults
XXXXXXXXXXXt 0.00 firm defaults
C = 5.83
S = 6.67
Equilibrium 2: early conversiontCoCo: tEquity:
= 2(100� 87.50)/(1 + 2)
= 1(100� 87.50)/(1 + 2)C = 8.33
S = 4.17
SW (CU,IU) Contingent Capital JF 12 / 23
![Page 138: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/138.jpg)
Pricing before maturity — CC and equityEquilibrium 1: late conversion
tCoCo:
tEquity:
⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t10.00 no conversion
⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t20.00 = (120� 90� 10)/1
t 6.67 convert to 2 shares
t 3.33 = (100� 90)/(1 + 2)
XXXXXXXXXXXt 0.00 firm defaults
XXXXXXXXXXXt 0.00 firm defaults
C = 5.83
S = 6.67
Equilibrium 2: early conversiontCoCo: tEquity:
= 2(100� 87.50)/(1 + 2)
= 1(100� 87.50)/(1 + 2)C = 8.33
S = 4.17
SW (CU,IU) Contingent Capital JF 12 / 23
![Page 139: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/139.jpg)
Pricing before maturity — CC and equityEquilibrium 1: late conversion
tCoCo:
tEquity:
⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t10.00 no conversion
⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t20.00 = (120� 90� 10)/1
t 6.67 convert to 2 shares
t 3.33 = (100� 90)/(1 + 2)
XXXXXXXXXXXt 0.00 firm defaults
XXXXXXXXXXXt 0.00 firm defaults
C = 5.83
S = 6.67
Equilibrium 2: early conversiontCoCo: tEquity:
= 2(100� 87.50)/(1 + 2)
= 1(100� 87.50)/(1 + 2)C = 8.33
S = 4.17
SW (CU,IU) Contingent Capital JF 12 / 23
![Page 140: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/140.jpg)
Pricing before maturity — CC and equityEquilibrium 1: late conversion
tCoCo:
tEquity:
⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t10.00 no conversion
⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t20.00 = (120� 90� 10)/1
t 6.67 convert to 2 shares
t 3.33 = (100� 90)/(1 + 2)
XXXXXXXXXXXt 0.00 firm defaults
XXXXXXXXXXXt 0.00 firm defaults
C = 5.83
S = 6.67
Equilibrium 2: early conversiontCoCo: tEquity:
= 2(100� 87.50)/(1 + 2)
= 1(100� 87.50)/(1 + 2)C = 8.33
S = 4.17
SW (CU,IU) Contingent Capital JF 12 / 23
![Page 141: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/141.jpg)
Pricing before maturity — CC and equityEquilibrium 1: late conversion
tCoCo:
tEquity:
⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t10.00 no conversion
⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t20.00 = (120� 90� 10)/1
t 6.67 convert to 2 shares
t 3.33 = (100� 90)/(1 + 2)
XXXXXXXXXXXt 0.00 firm defaults
XXXXXXXXXXXt 0.00 firm defaults
C = 5.83
S = 6.67
Equilibrium 2: early conversiontCoCo: tEquity:
= 2(100� 87.50)/(1 + 2)
= 1(100� 87.50)/(1 + 2)C = 8.33
S = 4.17
SW (CU,IU) Contingent Capital JF 12 / 23
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Pricing before maturity — CC and equityEquilibrium 1: late conversion
tCoCo:
tEquity:
⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t10.00 no conversion
⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t20.00 = (120� 90� 10)/1
t 6.67 convert to 2 shares
t 3.33 = (100� 90)/(1 + 2)
XXXXXXXXXXXt 0.00 firm defaults
XXXXXXXXXXXt 0.00 firm defaults
C = 5.83
S = 6.67
Equilibrium 2: early conversion
tCoCo: tEquity:
= 2(100� 87.50)/(1 + 2)
= 1(100� 87.50)/(1 + 2)C = 8.33
S = 4.17
SW (CU,IU) Contingent Capital JF 12 / 23
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Pricing before maturity — CC and equityEquilibrium 1: late conversion
tCoCo:
tEquity:
⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t10.00 no conversion
⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t20.00 = (120� 90� 10)/1
t 6.67 convert to 2 shares
t 3.33 = (100� 90)/(1 + 2)
XXXXXXXXXXXt 0.00 firm defaults
XXXXXXXXXXXt 0.00 firm defaults
C = 5.83
S = 6.67
Equilibrium 2: early conversiontCoCo: tEquity:
= 2(100� 87.50)/(1 + 2)
= 1(100� 87.50)/(1 + 2)C = 8.33
S = 4.17
SW (CU,IU) Contingent Capital JF 12 / 23
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Pricing before maturity — CC and equityEquilibrium 1: late conversion
tCoCo:
tEquity:
⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t10.00 no conversion
⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t20.00 = (120� 90� 10)/1
t 6.67 convert to 2 shares
t 3.33 = (100� 90)/(1 + 2)
XXXXXXXXXXXt 0.00 firm defaults
XXXXXXXXXXXt 0.00 firm defaults
C = 5.83
S = 6.67
Equilibrium 2: early conversiontCoCo: tEquity:
= 2(100� 87.50)/(1 + 2)
= 1(100� 87.50)/(1 + 2)
C = 8.33
S = 4.17
SW (CU,IU) Contingent Capital JF 12 / 23
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Pricing before maturity — CC and equityEquilibrium 1: late conversion
tCoCo:
tEquity:
⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t10.00 no conversion
⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠⇠t20.00 = (120� 90� 10)/1
t 6.67 convert to 2 shares
t 3.33 = (100� 90)/(1 + 2)
XXXXXXXXXXXt 0.00 firm defaults
XXXXXXXXXXXt 0.00 firm defaults
C = 5.83
S = 6.67
Equilibrium 2: early conversiontCoCo: tEquity:
= 2(100� 87.50)/(1 + 2)
= 1(100� 87.50)/(1 + 2)C = 8.33
S = 4.17
SW (CU,IU) Contingent Capital JF 12 / 23
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An example in dynamic continuous-time model
Asset: dAt = r Atdt + �Atdzt
Risk: zt = Brownian
current asset value A
0
100asset volatility � 4%
risk-free rate r 3%shares outstanding n 1
par value of bond B 87coupon rate of bond b 3.34%maturity of bond T 5 yearsbankruptcy cost ! 10%
par value of CC C 5coupon rate of CC c 0%maturity of CC T 5 yeartrigger on equity K 1conversion ratio m 5trigger verification ⇤ daily
firm value F
0
98.35bond value B
0
88.03stock price S
0
[5.86, 6.46]CC value C
0
[3.86, 4.46]
SW (CU,IU) Contingent Capital JF 13 / 23
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An example in dynamic continuous-time model
Asset: dAt = r Atdt + �Atdzt
Risk: zt = Brownian
current asset value A
0
100asset volatility � 4%
risk-free rate r 3%shares outstanding n 1
par value of bond B 87coupon rate of bond b 3.34%maturity of bond T 5 yearsbankruptcy cost ! 10%
par value of CC C 5coupon rate of CC c 0%maturity of CC T 5 yeartrigger on equity K 1conversion ratio m 5trigger verification ⇤ daily
firm value F
0
98.35bond value B
0
88.03stock price S
0
[5.86, 6.46]CC value C
0
[3.86, 4.46]
SW (CU,IU) Contingent Capital JF 13 / 23
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An example in dynamic continuous-time model
Asset: dAt = r Atdt + �Atdzt
Risk: zt = Brownian
current asset value A
0
100asset volatility � 4%
risk-free rate r 3%shares outstanding n 1
par value of bond B 87coupon rate of bond b 3.34%maturity of bond T 5 yearsbankruptcy cost ! 10%
par value of CC C 5coupon rate of CC c 0%maturity of CC T 5 yeartrigger on equity K 1conversion ratio m 5trigger verification ⇤ daily
firm value F
0
98.35bond value B
0
88.03stock price S
0
[5.86, 6.46]CC value C
0
[3.86, 4.46]
SW (CU,IU) Contingent Capital JF 13 / 23
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An example in dynamic continuous-time model
Asset: dAt = r Atdt + �Atdzt
Risk: zt = Brownian
current asset value A
0
100asset volatility � 4%
risk-free rate r 3%shares outstanding n 1
par value of bond B 87coupon rate of bond b 3.34%maturity of bond T 5 yearsbankruptcy cost ! 10%
par value of CC C 5coupon rate of CC c 0%maturity of CC T 5 yeartrigger on equity K 1conversion ratio m 5trigger verification ⇤ daily
firm value F
0
98.35bond value B
0
88.03stock price S
0
[5.86, 6.46]CC value C
0
[3.86, 4.46]
SW (CU,IU) Contingent Capital JF 13 / 23
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An example in dynamic continuous-time model
Asset: dAt = r Atdt + �Atdzt
Risk: zt = Brownian
current asset value A
0
100asset volatility � 4%
risk-free rate r 3%shares outstanding n 1
par value of bond B 87coupon rate of bond b 3.34%maturity of bond T 5 yearsbankruptcy cost ! 10%
par value of CC C 5coupon rate of CC c 0%maturity of CC T 5 yeartrigger on equity K 1conversion ratio m 5trigger verification ⇤ daily
firm value F
0
98.35bond value B
0
88.03stock price S
0
[5.86, 6.46]CC value C
0
[3.86, 4.46]
SW (CU,IU) Contingent Capital JF 13 / 23
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An example in dynamic continuous-time model
Asset: dAt = r Atdt + �Atdzt
Risk: zt = Brownian
current asset value A
0
100asset volatility � 4%
risk-free rate r 3%shares outstanding n 1
par value of bond B 87coupon rate of bond b 3.34%maturity of bond T 5 yearsbankruptcy cost ! 10%
par value of CC C 5coupon rate of CC c 0%maturity of CC T 5 yeartrigger on equity K 1conversion ratio m 5trigger verification ⇤ daily
firm value F
0
98.35bond value B
0
88.03stock price S
0
[5.86, 6.46]CC value C
0
[3.86, 4.46]
SW (CU,IU) Contingent Capital JF 13 / 23
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An example in dynamic continuous-time model
Asset: dAt = r Atdt + �Atdzt
Risk: zt = Brownian
current asset value A
0
100asset volatility � 4%
risk-free rate r 3%shares outstanding n 1
par value of bond B 87coupon rate of bond b 3.34%maturity of bond T 5 yearsbankruptcy cost ! 10%
par value of CC C 5coupon rate of CC c 0%maturity of CC T 5 yeartrigger on equity K 1conversion ratio m 5trigger verification ⇤ daily
firm value F
0
98.35bond value B
0
88.03stock price S
0
[5.86, 6.46]CC value C
0
[3.86, 4.46]
SW (CU,IU) Contingent Capital JF 13 / 23
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An example in dynamic continuous-time model
Asset: dAt = r Atdt + �Atdzt
Risk: zt = Brownian
current asset value A
0
100asset volatility � 4%
risk-free rate r 3%shares outstanding n 1
par value of bond B 87coupon rate of bond b 3.34%maturity of bond T 5 yearsbankruptcy cost ! 10%
par value of CC C 5coupon rate of CC c 0%maturity of CC T 5 yeartrigger on equity K 1conversion ratio m 5trigger verification ⇤ daily
firm value F
0
98.35bond value B
0
88.03stock price S
0
[5.86, 6.46]CC value C
0
[3.86, 4.46]
SW (CU,IU) Contingent Capital JF 13 / 23
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An example in dynamic continuous-time model
Asset: dAt = r Atdt + �Atdzt
Risk: zt = Brownian
current asset value A
0
100asset volatility � 4%
risk-free rate r 3%shares outstanding n 1
par value of bond B 87coupon rate of bond b 3.34%maturity of bond T 5 yearsbankruptcy cost ! 10%
par value of CC C 5coupon rate of CC c 0%maturity of CC T 5 yeartrigger on equity K 1conversion ratio m 5trigger verification ⇤ daily
firm value F
0
98.35bond value B
0
88.03stock price S
0
[5.86, 6.46]CC value C
0
[3.86, 4.46]
SW (CU,IU) Contingent Capital JF 13 / 23
![Page 155: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/155.jpg)
An example in dynamic continuous-time model
Asset: dAt = r Atdt + �Atdzt
Risk: zt = Brownian
current asset value A
0
100asset volatility � 4%
risk-free rate r 3%shares outstanding n 1
par value of bond B 87coupon rate of bond b 3.34%maturity of bond T 5 yearsbankruptcy cost ! 10%
par value of CC C 5coupon rate of CC c 0%maturity of CC T 5 yeartrigger on equity K 1conversion ratio m 5trigger verification ⇤ daily
firm value F
0
98.35bond value B
0
88.03stock price S
0
[5.86, 6.46]CC value C
0
[3.86, 4.46]
SW (CU,IU) Contingent Capital JF 13 / 23
![Page 156: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/156.jpg)
An example in jump di↵usion process
Asset: dAt = (r � �E[y � 1])Atdt + �Atdzt + (y � 1)Atdq
Risk: zt = Brownian, qt = Poisson(�), ln(y) ⇠ N(µy , �2
y )
current asset value A
0
100asset volatility � 4%arrival rate of jumps � 4mean of log-jump size µy �1%volatility of jump size �y 3%risk-free rate r 3%shares outstanding n 1
par value of bond B 87coupon rate of bond b 3.34%maturity of bond T 5 yearsbankruptcy cost ! 10%
par value of CC C 5coupon rate of CC c 0%maturity of CC T 5 yeartrigger on equity K 1conversion ratio m 5trigger verification ⇤ daily
firm value F
0
94.74bond value B
0
87.00stock price S
0
[3.84, 5.44]CC value C
0
[2.30, 3.90]
SW (CU,IU) Contingent Capital JF 14 / 23
![Page 157: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/157.jpg)
An example in jump di↵usion process
Asset: dAt = (r � �E[y � 1])Atdt + �Atdzt + (y � 1)Atdq
Risk: zt = Brownian, qt = Poisson(�), ln(y) ⇠ N(µy , �2
y )
current asset value A
0
100asset volatility � 4%arrival rate of jumps � 4mean of log-jump size µy �1%volatility of jump size �y 3%risk-free rate r 3%shares outstanding n 1
par value of bond B 87coupon rate of bond b 3.34%maturity of bond T 5 yearsbankruptcy cost ! 10%
par value of CC C 5coupon rate of CC c 0%maturity of CC T 5 yeartrigger on equity K 1conversion ratio m 5trigger verification ⇤ daily
firm value F
0
94.74bond value B
0
87.00stock price S
0
[3.84, 5.44]CC value C
0
[2.30, 3.90]
SW (CU,IU) Contingent Capital JF 14 / 23
![Page 158: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/158.jpg)
An example in jump di↵usion process
Asset: dAt = (r � �E[y � 1])Atdt + �Atdzt + (y � 1)Atdq
Risk: zt = Brownian, qt = Poisson(�), ln(y) ⇠ N(µy , �2
y )
current asset value A
0
100asset volatility � 4%arrival rate of jumps � 4mean of log-jump size µy �1%volatility of jump size �y 3%risk-free rate r 3%shares outstanding n 1
par value of bond B 87coupon rate of bond b 3.34%maturity of bond T 5 yearsbankruptcy cost ! 10%
par value of CC C 5coupon rate of CC c 0%maturity of CC T 5 yeartrigger on equity K 1conversion ratio m 5trigger verification ⇤ daily
firm value F
0
94.74bond value B
0
87.00stock price S
0
[3.84, 5.44]CC value C
0
[2.30, 3.90]
SW (CU,IU) Contingent Capital JF 14 / 23
![Page 159: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/159.jpg)
An example in jump di↵usion process
Asset: dAt = (r � �E[y � 1])Atdt + �Atdzt + (y � 1)Atdq
Risk: zt = Brownian, qt = Poisson(�), ln(y) ⇠ N(µy , �2
y )
current asset value A
0
100asset volatility � 4%arrival rate of jumps � 4mean of log-jump size µy �1%volatility of jump size �y 3%risk-free rate r 3%shares outstanding n 1
par value of bond B 87coupon rate of bond b 3.34%maturity of bond T 5 yearsbankruptcy cost ! 10%
par value of CC C 5coupon rate of CC c 0%maturity of CC T 5 yeartrigger on equity K 1conversion ratio m 5trigger verification ⇤ daily
firm value F
0
94.74bond value B
0
87.00stock price S
0
[3.84, 5.44]CC value C
0
[2.30, 3.90]
SW (CU,IU) Contingent Capital JF 14 / 23
![Page 160: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/160.jpg)
An example in jump di↵usion process
Asset: dAt = (r � �E[y � 1])Atdt + �Atdzt + (y � 1)Atdq
Risk: zt = Brownian, qt = Poisson(�), ln(y) ⇠ N(µy , �2
y )
current asset value A
0
100asset volatility � 4%arrival rate of jumps � 4mean of log-jump size µy �1%volatility of jump size �y 3%risk-free rate r 3%shares outstanding n 1
par value of bond B 87coupon rate of bond b 3.34%maturity of bond T 5 yearsbankruptcy cost ! 10%
par value of CC C 5coupon rate of CC c 0%maturity of CC T 5 yeartrigger on equity K 1conversion ratio m 5trigger verification ⇤ daily
firm value F
0
94.74bond value B
0
87.00stock price S
0
[3.84, 5.44]CC value C
0
[2.30, 3.90]
SW (CU,IU) Contingent Capital JF 14 / 23
![Page 161: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/161.jpg)
An example in jump di↵usion process
Asset: dAt = (r � �E[y � 1])Atdt + �Atdzt + (y � 1)Atdq
Risk: zt = Brownian, qt = Poisson(�), ln(y) ⇠ N(µy , �2
y )
current asset value A
0
100asset volatility � 4%arrival rate of jumps � 4mean of log-jump size µy �1%volatility of jump size �y 3%risk-free rate r 3%shares outstanding n 1
par value of bond B 87coupon rate of bond b 3.34%maturity of bond T 5 yearsbankruptcy cost ! 10%
par value of CC C 5coupon rate of CC c 0%maturity of CC T 5 yeartrigger on equity K 1conversion ratio m 5trigger verification ⇤ daily
firm value F
0
94.74bond value B
0
87.00stock price S
0
[3.84, 5.44]CC value C
0
[2.30, 3.90]
SW (CU,IU) Contingent Capital JF 14 / 23
![Page 162: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/162.jpg)
An example in jump di↵usion process
Asset: dAt = (r � �E[y � 1])Atdt + �Atdzt + (y � 1)Atdq
Risk: zt = Brownian, qt = Poisson(�), ln(y) ⇠ N(µy , �2
y )
current asset value A
0
100asset volatility � 4%arrival rate of jumps � 4mean of log-jump size µy �1%volatility of jump size �y 3%risk-free rate r 3%shares outstanding n 1
par value of bond B 87coupon rate of bond b 3.34%maturity of bond T 5 yearsbankruptcy cost ! 10%
par value of CC C 5coupon rate of CC c 0%maturity of CC T 5 yeartrigger on equity K 1conversion ratio m 5trigger verification ⇤ daily
firm value F
0
94.74bond value B
0
87.00stock price S
0
[3.84, 5.44]CC value C
0
[2.30, 3.90]
SW (CU,IU) Contingent Capital JF 14 / 23
![Page 163: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/163.jpg)
An example in jump di↵usion process
Asset: dAt = (r � �E[y � 1])Atdt + �Atdzt + (y � 1)Atdq
Risk: zt = Brownian, qt = Poisson(�), ln(y) ⇠ N(µy , �2
y )
current asset value A
0
100asset volatility � 4%arrival rate of jumps � 4mean of log-jump size µy �1%volatility of jump size �y 3%risk-free rate r 3%shares outstanding n 1
par value of bond B 87coupon rate of bond b 3.34%maturity of bond T 5 yearsbankruptcy cost ! 10%
par value of CC C 5coupon rate of CC c 0%maturity of CC T 5 yeartrigger on equity K 1conversion ratio m 5trigger verification ⇤ daily
firm value F
0
94.74bond value B
0
87.00stock price S
0
[3.84, 5.44]CC value C
0
[2.30, 3.90]
SW (CU,IU) Contingent Capital JF 14 / 23
![Page 164: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/164.jpg)
An example in jump di↵usion process
Asset: dAt = (r � �E[y � 1])Atdt + �Atdzt + (y � 1)Atdq
Risk: zt = Brownian, qt = Poisson(�), ln(y) ⇠ N(µy , �2
y )
current asset value A
0
100asset volatility � 4%arrival rate of jumps � 4mean of log-jump size µy �1%volatility of jump size �y 3%risk-free rate r 3%shares outstanding n 1
par value of bond B 87coupon rate of bond b 3.34%maturity of bond T 5 yearsbankruptcy cost ! 10%
par value of CC C 5coupon rate of CC c 0%maturity of CC T 5 yeartrigger on equity K 1conversion ratio m 5trigger verification ⇤ daily
firm value F
0
94.74bond value B
0
87.00stock price S
0
[3.84, 5.44]CC value C
0
[2.30, 3.90]
SW (CU,IU) Contingent Capital JF 14 / 23
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An example in jump di↵usion process
Asset: dAt = (r � �E[y � 1])Atdt + �Atdzt + (y � 1)Atdq
Risk: zt = Brownian, qt = Poisson(�), ln(y) ⇠ N(µy , �2
y )
current asset value A
0
100asset volatility � 4%arrival rate of jumps � 4mean of log-jump size µy �1%volatility of jump size �y 3%risk-free rate r 3%shares outstanding n 1
par value of bond B 87coupon rate of bond b 3.34%maturity of bond T 5 yearsbankruptcy cost ! 10%
par value of CC C 5coupon rate of CC c 0%maturity of CC T 5 yeartrigger on equity K 1conversion ratio m 5trigger verification ⇤ daily
firm value F
0
94.74bond value B
0
87.00stock price S
0
[3.84, 5.44]CC value C
0
[2.30, 3.90]
SW (CU,IU) Contingent Capital JF 14 / 23
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If conversion transfers value from equity to CC
0
10
20
30
40
50
60
70
80
90
100
0
10
20
30
40
50
60
70
80
90
100
0 20 40 60 80 100 120 140 160 180 200
Equity value if not converted
Number of Weeks
Trigger = 40
Transfer 10 out from equity Equity value if converted
Value Value
SW (CU,IU) Contingent Capital JF 15 / 23
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If conversion transfers value from CC to equity
0
10
20
30
40
50
60
70
80
90
100
0
10
20
30
40
50
60
70
80
90
100
0 20 40 60 80 100 120 140 160 180 200
Value
Equity value if not converted
Number of Weeks
Trigger = 40
Transfer 10 into equity.
Equity value if converted
A sudden large loss causes equity value to jump below trigger.
Value
SW (CU,IU) Contingent Capital JF 16 / 23
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Necessary condition for a unique equilibrium
Theorem 1
CC contract specifies trigger Kt and conversion ratio mt
CC contract specifies the set of trigger verification time ⇤If a unique pair of dynamic rational expectations equilibrium ofstock price and CC value (St ,Ct) exists, then
mt = Ct/(Kt/n) for all t 2 ⇤
Underlying assumptions
asset value is risky (di↵usion process)sudden large loss is possible (jump risk)bankruptcy is costly (loss of asset value at default)
Implications
Setting mt to have unique equilibrium requires observing Ct
For constant m and K , it requires Ct = mK/nCC conversion cannot be punitive: m⌧S⌧ m⌧K⌧/n = C⌧
SW (CU,IU) Contingent Capital JF 17 / 23
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Necessary condition for a unique equilibrium
Theorem 1
CC contract specifies trigger Kt and conversion ratio mt
CC contract specifies the set of trigger verification time ⇤If a unique pair of dynamic rational expectations equilibrium ofstock price and CC value (St ,Ct) exists, then
mt = Ct/(Kt/n) for all t 2 ⇤
Underlying assumptions
asset value is risky (di↵usion process)sudden large loss is possible (jump risk)bankruptcy is costly (loss of asset value at default)
Implications
Setting mt to have unique equilibrium requires observing Ct
For constant m and K , it requires Ct = mK/nCC conversion cannot be punitive: m⌧S⌧ m⌧K⌧/n = C⌧
SW (CU,IU) Contingent Capital JF 17 / 23
![Page 170: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/170.jpg)
Necessary condition for a unique equilibrium
Theorem 1
CC contract specifies trigger Kt and conversion ratio mt
CC contract specifies the set of trigger verification time ⇤If a unique pair of dynamic rational expectations equilibrium ofstock price and CC value (St ,Ct) exists, then
mt = Ct/(Kt/n) for all t 2 ⇤
Underlying assumptions
asset value is risky (di↵usion process)sudden large loss is possible (jump risk)bankruptcy is costly (loss of asset value at default)
Implications
Setting mt to have unique equilibrium requires observing Ct
For constant m and K , it requires Ct = mK/nCC conversion cannot be punitive: m⌧S⌧ m⌧K⌧/n = C⌧
SW (CU,IU) Contingent Capital JF 17 / 23
![Page 171: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/171.jpg)
Necessary condition for a unique equilibrium
Theorem 1
CC contract specifies trigger Kt and conversion ratio mt
CC contract specifies the set of trigger verification time ⇤
If a unique pair of dynamic rational expectations equilibrium ofstock price and CC value (St ,Ct) exists, then
mt = Ct/(Kt/n) for all t 2 ⇤
Underlying assumptions
asset value is risky (di↵usion process)sudden large loss is possible (jump risk)bankruptcy is costly (loss of asset value at default)
Implications
Setting mt to have unique equilibrium requires observing Ct
For constant m and K , it requires Ct = mK/nCC conversion cannot be punitive: m⌧S⌧ m⌧K⌧/n = C⌧
SW (CU,IU) Contingent Capital JF 17 / 23
![Page 172: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/172.jpg)
Necessary condition for a unique equilibrium
Theorem 1
CC contract specifies trigger Kt and conversion ratio mt
CC contract specifies the set of trigger verification time ⇤If a unique pair of dynamic rational expectations equilibrium ofstock price and CC value (St ,Ct) exists, then
mt = Ct/(Kt/n) for all t 2 ⇤
Underlying assumptions
asset value is risky (di↵usion process)sudden large loss is possible (jump risk)bankruptcy is costly (loss of asset value at default)
Implications
Setting mt to have unique equilibrium requires observing Ct
For constant m and K , it requires Ct = mK/nCC conversion cannot be punitive: m⌧S⌧ m⌧K⌧/n = C⌧
SW (CU,IU) Contingent Capital JF 17 / 23
![Page 173: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/173.jpg)
Necessary condition for a unique equilibrium
Theorem 1
CC contract specifies trigger Kt and conversion ratio mt
CC contract specifies the set of trigger verification time ⇤If a unique pair of dynamic rational expectations equilibrium ofstock price and CC value (St ,Ct) exists, then
mt = Ct/(Kt/n) for all t 2 ⇤
Underlying assumptions
asset value is risky (di↵usion process)sudden large loss is possible (jump risk)bankruptcy is costly (loss of asset value at default)
Implications
Setting mt to have unique equilibrium requires observing Ct
For constant m and K , it requires Ct = mK/nCC conversion cannot be punitive: m⌧S⌧ m⌧K⌧/n = C⌧
SW (CU,IU) Contingent Capital JF 17 / 23
![Page 174: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/174.jpg)
Necessary condition for a unique equilibrium
Theorem 1
CC contract specifies trigger Kt and conversion ratio mt
CC contract specifies the set of trigger verification time ⇤If a unique pair of dynamic rational expectations equilibrium ofstock price and CC value (St ,Ct) exists, then
mt = Ct/(Kt/n) for all t 2 ⇤
Underlying assumptions
asset value is risky (di↵usion process)sudden large loss is possible (jump risk)bankruptcy is costly (loss of asset value at default)
Implications
Setting mt to have unique equilibrium requires observing Ct
For constant m and K , it requires Ct = mK/nCC conversion cannot be punitive: m⌧S⌧ m⌧K⌧/n = C⌧
SW (CU,IU) Contingent Capital JF 17 / 23
![Page 175: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/175.jpg)
Necessary condition for a unique equilibrium
Theorem 1
CC contract specifies trigger Kt and conversion ratio mt
CC contract specifies the set of trigger verification time ⇤If a unique pair of dynamic rational expectations equilibrium ofstock price and CC value (St ,Ct) exists, then
mt = Ct/(Kt/n) for all t 2 ⇤
Underlying assumptions
asset value is risky (di↵usion process)
sudden large loss is possible (jump risk)bankruptcy is costly (loss of asset value at default)
Implications
Setting mt to have unique equilibrium requires observing Ct
For constant m and K , it requires Ct = mK/nCC conversion cannot be punitive: m⌧S⌧ m⌧K⌧/n = C⌧
SW (CU,IU) Contingent Capital JF 17 / 23
![Page 176: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/176.jpg)
Necessary condition for a unique equilibrium
Theorem 1
CC contract specifies trigger Kt and conversion ratio mt
CC contract specifies the set of trigger verification time ⇤If a unique pair of dynamic rational expectations equilibrium ofstock price and CC value (St ,Ct) exists, then
mt = Ct/(Kt/n) for all t 2 ⇤
Underlying assumptions
asset value is risky (di↵usion process)sudden large loss is possible (jump risk)
bankruptcy is costly (loss of asset value at default)
Implications
Setting mt to have unique equilibrium requires observing Ct
For constant m and K , it requires Ct = mK/nCC conversion cannot be punitive: m⌧S⌧ m⌧K⌧/n = C⌧
SW (CU,IU) Contingent Capital JF 17 / 23
![Page 177: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/177.jpg)
Necessary condition for a unique equilibrium
Theorem 1
CC contract specifies trigger Kt and conversion ratio mt
CC contract specifies the set of trigger verification time ⇤If a unique pair of dynamic rational expectations equilibrium ofstock price and CC value (St ,Ct) exists, then
mt = Ct/(Kt/n) for all t 2 ⇤
Underlying assumptions
asset value is risky (di↵usion process)sudden large loss is possible (jump risk)bankruptcy is costly (loss of asset value at default)
Implications
Setting mt to have unique equilibrium requires observing Ct
For constant m and K , it requires Ct = mK/nCC conversion cannot be punitive: m⌧S⌧ m⌧K⌧/n = C⌧
SW (CU,IU) Contingent Capital JF 17 / 23
![Page 178: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/178.jpg)
Necessary condition for a unique equilibrium
Theorem 1
CC contract specifies trigger Kt and conversion ratio mt
CC contract specifies the set of trigger verification time ⇤If a unique pair of dynamic rational expectations equilibrium ofstock price and CC value (St ,Ct) exists, then
mt = Ct/(Kt/n) for all t 2 ⇤
Underlying assumptions
asset value is risky (di↵usion process)sudden large loss is possible (jump risk)bankruptcy is costly (loss of asset value at default)
Implications
Setting mt to have unique equilibrium requires observing Ct
For constant m and K , it requires Ct = mK/nCC conversion cannot be punitive: m⌧S⌧ m⌧K⌧/n = C⌧
SW (CU,IU) Contingent Capital JF 17 / 23
![Page 179: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/179.jpg)
Necessary condition for a unique equilibrium
Theorem 1
CC contract specifies trigger Kt and conversion ratio mt
CC contract specifies the set of trigger verification time ⇤If a unique pair of dynamic rational expectations equilibrium ofstock price and CC value (St ,Ct) exists, then
mt = Ct/(Kt/n) for all t 2 ⇤
Underlying assumptions
asset value is risky (di↵usion process)sudden large loss is possible (jump risk)bankruptcy is costly (loss of asset value at default)
Implications
Setting mt to have unique equilibrium requires observing Ct
For constant m and K , it requires Ct = mK/nCC conversion cannot be punitive: m⌧S⌧ m⌧K⌧/n = C⌧
SW (CU,IU) Contingent Capital JF 17 / 23
![Page 180: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/180.jpg)
Necessary condition for a unique equilibrium
Theorem 1
CC contract specifies trigger Kt and conversion ratio mt
CC contract specifies the set of trigger verification time ⇤If a unique pair of dynamic rational expectations equilibrium ofstock price and CC value (St ,Ct) exists, then
mt = Ct/(Kt/n) for all t 2 ⇤
Underlying assumptions
asset value is risky (di↵usion process)sudden large loss is possible (jump risk)bankruptcy is costly (loss of asset value at default)
Implications
Setting mt to have unique equilibrium requires observing Ct
For constant m and K , it requires Ct = mK/n
CC conversion cannot be punitive: m⌧S⌧ m⌧K⌧/n = C⌧
SW (CU,IU) Contingent Capital JF 17 / 23
![Page 181: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/181.jpg)
Necessary condition for a unique equilibrium
Theorem 1
CC contract specifies trigger Kt and conversion ratio mt
CC contract specifies the set of trigger verification time ⇤If a unique pair of dynamic rational expectations equilibrium ofstock price and CC value (St ,Ct) exists, then
mt = Ct/(Kt/n) for all t 2 ⇤
Underlying assumptions
asset value is risky (di↵usion process)sudden large loss is possible (jump risk)bankruptcy is costly (loss of asset value at default)
Implications
Setting mt to have unique equilibrium requires observing Ct
For constant m and K , it requires Ct = mK/nCC conversion cannot be punitive: m⌧S⌧ m⌧K⌧/n = C⌧
SW (CU,IU) Contingent Capital JF 17 / 23
![Page 182: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/182.jpg)
Other pricing models
Albul, Je↵ee & Tchistyi (’10), Tsyplakov & Himmelberg (’12)
firm value is exogenousplace trigger on firm value, not equity value
Pennacchi (’11)
firm value is exogenousshort-term deposits are always priced at par and exogenousplace trigger on (asset � deposits) / deposits
McDonald (’11)
market index and firm equity value are exogenoususe double riggers on both market index and equity value
Glasserman & Nouri (’12)
firm value is exogenous: geometric brownian motion“book equity value” is non-stochasticplace trigger on “book equity value” / firm value
SW (CU,IU) Contingent Capital JF 18 / 23
![Page 183: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/183.jpg)
Other pricing models
Albul, Je↵ee & Tchistyi (’10), Tsyplakov & Himmelberg (’12)
firm value is exogenousplace trigger on firm value, not equity value
Pennacchi (’11)
firm value is exogenousshort-term deposits are always priced at par and exogenousplace trigger on (asset � deposits) / deposits
McDonald (’11)
market index and firm equity value are exogenoususe double riggers on both market index and equity value
Glasserman & Nouri (’12)
firm value is exogenous: geometric brownian motion“book equity value” is non-stochasticplace trigger on “book equity value” / firm value
SW (CU,IU) Contingent Capital JF 18 / 23
![Page 184: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/184.jpg)
Other pricing models
Albul, Je↵ee & Tchistyi (’10), Tsyplakov & Himmelberg (’12)
firm value is exogenous
place trigger on firm value, not equity value
Pennacchi (’11)
firm value is exogenousshort-term deposits are always priced at par and exogenousplace trigger on (asset � deposits) / deposits
McDonald (’11)
market index and firm equity value are exogenoususe double riggers on both market index and equity value
Glasserman & Nouri (’12)
firm value is exogenous: geometric brownian motion“book equity value” is non-stochasticplace trigger on “book equity value” / firm value
SW (CU,IU) Contingent Capital JF 18 / 23
![Page 185: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/185.jpg)
Other pricing models
Albul, Je↵ee & Tchistyi (’10), Tsyplakov & Himmelberg (’12)
firm value is exogenousplace trigger on firm value, not equity value
Pennacchi (’11)
firm value is exogenousshort-term deposits are always priced at par and exogenousplace trigger on (asset � deposits) / deposits
McDonald (’11)
market index and firm equity value are exogenoususe double riggers on both market index and equity value
Glasserman & Nouri (’12)
firm value is exogenous: geometric brownian motion“book equity value” is non-stochasticplace trigger on “book equity value” / firm value
SW (CU,IU) Contingent Capital JF 18 / 23
![Page 186: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/186.jpg)
Other pricing models
Albul, Je↵ee & Tchistyi (’10), Tsyplakov & Himmelberg (’12)
firm value is exogenousplace trigger on firm value, not equity value
Pennacchi (’11)
firm value is exogenousshort-term deposits are always priced at par and exogenousplace trigger on (asset � deposits) / deposits
McDonald (’11)
market index and firm equity value are exogenoususe double riggers on both market index and equity value
Glasserman & Nouri (’12)
firm value is exogenous: geometric brownian motion“book equity value” is non-stochasticplace trigger on “book equity value” / firm value
SW (CU,IU) Contingent Capital JF 18 / 23
![Page 187: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/187.jpg)
Other pricing models
Albul, Je↵ee & Tchistyi (’10), Tsyplakov & Himmelberg (’12)
firm value is exogenousplace trigger on firm value, not equity value
Pennacchi (’11)
firm value is exogenous
short-term deposits are always priced at par and exogenousplace trigger on (asset � deposits) / deposits
McDonald (’11)
market index and firm equity value are exogenoususe double riggers on both market index and equity value
Glasserman & Nouri (’12)
firm value is exogenous: geometric brownian motion“book equity value” is non-stochasticplace trigger on “book equity value” / firm value
SW (CU,IU) Contingent Capital JF 18 / 23
![Page 188: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/188.jpg)
Other pricing models
Albul, Je↵ee & Tchistyi (’10), Tsyplakov & Himmelberg (’12)
firm value is exogenousplace trigger on firm value, not equity value
Pennacchi (’11)
firm value is exogenousshort-term deposits are always priced at par and exogenous
place trigger on (asset � deposits) / deposits
McDonald (’11)
market index and firm equity value are exogenoususe double riggers on both market index and equity value
Glasserman & Nouri (’12)
firm value is exogenous: geometric brownian motion“book equity value” is non-stochasticplace trigger on “book equity value” / firm value
SW (CU,IU) Contingent Capital JF 18 / 23
![Page 189: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/189.jpg)
Other pricing models
Albul, Je↵ee & Tchistyi (’10), Tsyplakov & Himmelberg (’12)
firm value is exogenousplace trigger on firm value, not equity value
Pennacchi (’11)
firm value is exogenousshort-term deposits are always priced at par and exogenousplace trigger on (asset � deposits) / deposits
McDonald (’11)
market index and firm equity value are exogenoususe double riggers on both market index and equity value
Glasserman & Nouri (’12)
firm value is exogenous: geometric brownian motion“book equity value” is non-stochasticplace trigger on “book equity value” / firm value
SW (CU,IU) Contingent Capital JF 18 / 23
![Page 190: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/190.jpg)
Other pricing models
Albul, Je↵ee & Tchistyi (’10), Tsyplakov & Himmelberg (’12)
firm value is exogenousplace trigger on firm value, not equity value
Pennacchi (’11)
firm value is exogenousshort-term deposits are always priced at par and exogenousplace trigger on (asset � deposits) / deposits
McDonald (’11)
market index and firm equity value are exogenoususe double riggers on both market index and equity value
Glasserman & Nouri (’12)
firm value is exogenous: geometric brownian motion“book equity value” is non-stochasticplace trigger on “book equity value” / firm value
SW (CU,IU) Contingent Capital JF 18 / 23
![Page 191: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/191.jpg)
Other pricing models
Albul, Je↵ee & Tchistyi (’10), Tsyplakov & Himmelberg (’12)
firm value is exogenousplace trigger on firm value, not equity value
Pennacchi (’11)
firm value is exogenousshort-term deposits are always priced at par and exogenousplace trigger on (asset � deposits) / deposits
McDonald (’11)
market index and firm equity value are exogenous
use double riggers on both market index and equity value
Glasserman & Nouri (’12)
firm value is exogenous: geometric brownian motion“book equity value” is non-stochasticplace trigger on “book equity value” / firm value
SW (CU,IU) Contingent Capital JF 18 / 23
![Page 192: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/192.jpg)
Other pricing models
Albul, Je↵ee & Tchistyi (’10), Tsyplakov & Himmelberg (’12)
firm value is exogenousplace trigger on firm value, not equity value
Pennacchi (’11)
firm value is exogenousshort-term deposits are always priced at par and exogenousplace trigger on (asset � deposits) / deposits
McDonald (’11)
market index and firm equity value are exogenoususe double riggers on both market index and equity value
Glasserman & Nouri (’12)
firm value is exogenous: geometric brownian motion“book equity value” is non-stochasticplace trigger on “book equity value” / firm value
SW (CU,IU) Contingent Capital JF 18 / 23
![Page 193: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/193.jpg)
Other pricing models
Albul, Je↵ee & Tchistyi (’10), Tsyplakov & Himmelberg (’12)
firm value is exogenousplace trigger on firm value, not equity value
Pennacchi (’11)
firm value is exogenousshort-term deposits are always priced at par and exogenousplace trigger on (asset � deposits) / deposits
McDonald (’11)
market index and firm equity value are exogenoususe double riggers on both market index and equity value
Glasserman & Nouri (’12)
firm value is exogenous: geometric brownian motion“book equity value” is non-stochasticplace trigger on “book equity value” / firm value
SW (CU,IU) Contingent Capital JF 18 / 23
![Page 194: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/194.jpg)
Other pricing models
Albul, Je↵ee & Tchistyi (’10), Tsyplakov & Himmelberg (’12)
firm value is exogenousplace trigger on firm value, not equity value
Pennacchi (’11)
firm value is exogenousshort-term deposits are always priced at par and exogenousplace trigger on (asset � deposits) / deposits
McDonald (’11)
market index and firm equity value are exogenoususe double riggers on both market index and equity value
Glasserman & Nouri (’12)
firm value is exogenous: geometric brownian motion
“book equity value” is non-stochasticplace trigger on “book equity value” / firm value
SW (CU,IU) Contingent Capital JF 18 / 23
![Page 195: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/195.jpg)
Other pricing models
Albul, Je↵ee & Tchistyi (’10), Tsyplakov & Himmelberg (’12)
firm value is exogenousplace trigger on firm value, not equity value
Pennacchi (’11)
firm value is exogenousshort-term deposits are always priced at par and exogenousplace trigger on (asset � deposits) / deposits
McDonald (’11)
market index and firm equity value are exogenoususe double riggers on both market index and equity value
Glasserman & Nouri (’12)
firm value is exogenous: geometric brownian motion“book equity value” is non-stochastic
place trigger on “book equity value” / firm value
SW (CU,IU) Contingent Capital JF 18 / 23
![Page 196: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/196.jpg)
Other pricing models
Albul, Je↵ee & Tchistyi (’10), Tsyplakov & Himmelberg (’12)
firm value is exogenousplace trigger on firm value, not equity value
Pennacchi (’11)
firm value is exogenousshort-term deposits are always priced at par and exogenousplace trigger on (asset � deposits) / deposits
McDonald (’11)
market index and firm equity value are exogenoususe double riggers on both market index and equity value
Glasserman & Nouri (’12)
firm value is exogenous: geometric brownian motion“book equity value” is non-stochasticplace trigger on “book equity value” / firm value
SW (CU,IU) Contingent Capital JF 18 / 23
![Page 197: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/197.jpg)
The problems without a unique equilibrium
Economic theory
A unique equilibrium is often associated with
a stable market pricean e�cient asset allocation
Lack of unique equilibrium leaves price to uncertain forces
unknown how investors’ formation of expectationunknown about asset allocation e�ciency
Price manipulation and market instability
Equity holders prefer the equilibrium that avoids conversionCC holders prefer the equilibrium that forces conversion
Lab experiment [Davis, Prescott & Korenok (2011)]
stock price is highly uncertainassets are allocated ine�cientlyfrequent conversion errors
SW (CU,IU) Contingent Capital JF 19 / 23
![Page 198: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/198.jpg)
The problems without a unique equilibrium
Economic theory
A unique equilibrium is often associated with
a stable market pricean e�cient asset allocation
Lack of unique equilibrium leaves price to uncertain forces
unknown how investors’ formation of expectationunknown about asset allocation e�ciency
Price manipulation and market instability
Equity holders prefer the equilibrium that avoids conversionCC holders prefer the equilibrium that forces conversion
Lab experiment [Davis, Prescott & Korenok (2011)]
stock price is highly uncertainassets are allocated ine�cientlyfrequent conversion errors
SW (CU,IU) Contingent Capital JF 19 / 23
![Page 199: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/199.jpg)
The problems without a unique equilibrium
Economic theory
A unique equilibrium is often associated with
a stable market pricean e�cient asset allocation
Lack of unique equilibrium leaves price to uncertain forces
unknown how investors’ formation of expectationunknown about asset allocation e�ciency
Price manipulation and market instability
Equity holders prefer the equilibrium that avoids conversionCC holders prefer the equilibrium that forces conversion
Lab experiment [Davis, Prescott & Korenok (2011)]
stock price is highly uncertainassets are allocated ine�cientlyfrequent conversion errors
SW (CU,IU) Contingent Capital JF 19 / 23
![Page 200: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/200.jpg)
The problems without a unique equilibrium
Economic theory
A unique equilibrium is often associated with
a stable market price
an e�cient asset allocation
Lack of unique equilibrium leaves price to uncertain forces
unknown how investors’ formation of expectationunknown about asset allocation e�ciency
Price manipulation and market instability
Equity holders prefer the equilibrium that avoids conversionCC holders prefer the equilibrium that forces conversion
Lab experiment [Davis, Prescott & Korenok (2011)]
stock price is highly uncertainassets are allocated ine�cientlyfrequent conversion errors
SW (CU,IU) Contingent Capital JF 19 / 23
![Page 201: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/201.jpg)
The problems without a unique equilibrium
Economic theory
A unique equilibrium is often associated with
a stable market pricean e�cient asset allocation
Lack of unique equilibrium leaves price to uncertain forces
unknown how investors’ formation of expectationunknown about asset allocation e�ciency
Price manipulation and market instability
Equity holders prefer the equilibrium that avoids conversionCC holders prefer the equilibrium that forces conversion
Lab experiment [Davis, Prescott & Korenok (2011)]
stock price is highly uncertainassets are allocated ine�cientlyfrequent conversion errors
SW (CU,IU) Contingent Capital JF 19 / 23
![Page 202: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/202.jpg)
The problems without a unique equilibrium
Economic theory
A unique equilibrium is often associated with
a stable market pricean e�cient asset allocation
Lack of unique equilibrium leaves price to uncertain forces
unknown how investors’ formation of expectationunknown about asset allocation e�ciency
Price manipulation and market instability
Equity holders prefer the equilibrium that avoids conversionCC holders prefer the equilibrium that forces conversion
Lab experiment [Davis, Prescott & Korenok (2011)]
stock price is highly uncertainassets are allocated ine�cientlyfrequent conversion errors
SW (CU,IU) Contingent Capital JF 19 / 23
![Page 203: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/203.jpg)
The problems without a unique equilibrium
Economic theory
A unique equilibrium is often associated with
a stable market pricean e�cient asset allocation
Lack of unique equilibrium leaves price to uncertain forces
unknown how investors’ formation of expectation
unknown about asset allocation e�ciency
Price manipulation and market instability
Equity holders prefer the equilibrium that avoids conversionCC holders prefer the equilibrium that forces conversion
Lab experiment [Davis, Prescott & Korenok (2011)]
stock price is highly uncertainassets are allocated ine�cientlyfrequent conversion errors
SW (CU,IU) Contingent Capital JF 19 / 23
![Page 204: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/204.jpg)
The problems without a unique equilibrium
Economic theory
A unique equilibrium is often associated with
a stable market pricean e�cient asset allocation
Lack of unique equilibrium leaves price to uncertain forces
unknown how investors’ formation of expectationunknown about asset allocation e�ciency
Price manipulation and market instability
Equity holders prefer the equilibrium that avoids conversionCC holders prefer the equilibrium that forces conversion
Lab experiment [Davis, Prescott & Korenok (2011)]
stock price is highly uncertainassets are allocated ine�cientlyfrequent conversion errors
SW (CU,IU) Contingent Capital JF 19 / 23
![Page 205: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/205.jpg)
The problems without a unique equilibrium
Economic theory
A unique equilibrium is often associated with
a stable market pricean e�cient asset allocation
Lack of unique equilibrium leaves price to uncertain forces
unknown how investors’ formation of expectationunknown about asset allocation e�ciency
Price manipulation and market instability
Equity holders prefer the equilibrium that avoids conversionCC holders prefer the equilibrium that forces conversion
Lab experiment [Davis, Prescott & Korenok (2011)]
stock price is highly uncertainassets are allocated ine�cientlyfrequent conversion errors
SW (CU,IU) Contingent Capital JF 19 / 23
![Page 206: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/206.jpg)
The problems without a unique equilibrium
Economic theory
A unique equilibrium is often associated with
a stable market pricean e�cient asset allocation
Lack of unique equilibrium leaves price to uncertain forces
unknown how investors’ formation of expectationunknown about asset allocation e�ciency
Price manipulation and market instability
Equity holders prefer the equilibrium that avoids conversion
CC holders prefer the equilibrium that forces conversion
Lab experiment [Davis, Prescott & Korenok (2011)]
stock price is highly uncertainassets are allocated ine�cientlyfrequent conversion errors
SW (CU,IU) Contingent Capital JF 19 / 23
![Page 207: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/207.jpg)
The problems without a unique equilibrium
Economic theory
A unique equilibrium is often associated with
a stable market pricean e�cient asset allocation
Lack of unique equilibrium leaves price to uncertain forces
unknown how investors’ formation of expectationunknown about asset allocation e�ciency
Price manipulation and market instability
Equity holders prefer the equilibrium that avoids conversionCC holders prefer the equilibrium that forces conversion
Lab experiment [Davis, Prescott & Korenok (2011)]
stock price is highly uncertainassets are allocated ine�cientlyfrequent conversion errors
SW (CU,IU) Contingent Capital JF 19 / 23
![Page 208: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/208.jpg)
The problems without a unique equilibrium
Economic theory
A unique equilibrium is often associated with
a stable market pricean e�cient asset allocation
Lack of unique equilibrium leaves price to uncertain forces
unknown how investors’ formation of expectationunknown about asset allocation e�ciency
Price manipulation and market instability
Equity holders prefer the equilibrium that avoids conversionCC holders prefer the equilibrium that forces conversion
Lab experiment [Davis, Prescott & Korenok (2011)]
stock price is highly uncertainassets are allocated ine�cientlyfrequent conversion errors
SW (CU,IU) Contingent Capital JF 19 / 23
![Page 209: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/209.jpg)
The problems without a unique equilibrium
Economic theory
A unique equilibrium is often associated with
a stable market pricean e�cient asset allocation
Lack of unique equilibrium leaves price to uncertain forces
unknown how investors’ formation of expectationunknown about asset allocation e�ciency
Price manipulation and market instability
Equity holders prefer the equilibrium that avoids conversionCC holders prefer the equilibrium that forces conversion
Lab experiment [Davis, Prescott & Korenok (2011)]
stock price is highly uncertain
assets are allocated ine�cientlyfrequent conversion errors
SW (CU,IU) Contingent Capital JF 19 / 23
![Page 210: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/210.jpg)
The problems without a unique equilibrium
Economic theory
A unique equilibrium is often associated with
a stable market pricean e�cient asset allocation
Lack of unique equilibrium leaves price to uncertain forces
unknown how investors’ formation of expectationunknown about asset allocation e�ciency
Price manipulation and market instability
Equity holders prefer the equilibrium that avoids conversionCC holders prefer the equilibrium that forces conversion
Lab experiment [Davis, Prescott & Korenok (2011)]
stock price is highly uncertainassets are allocated ine�ciently
frequent conversion errors
SW (CU,IU) Contingent Capital JF 19 / 23
![Page 211: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/211.jpg)
The problems without a unique equilibrium
Economic theory
A unique equilibrium is often associated with
a stable market pricean e�cient asset allocation
Lack of unique equilibrium leaves price to uncertain forces
unknown how investors’ formation of expectationunknown about asset allocation e�ciency
Price manipulation and market instability
Equity holders prefer the equilibrium that avoids conversionCC holders prefer the equilibrium that forces conversion
Lab experiment [Davis, Prescott & Korenok (2011)]
stock price is highly uncertainassets are allocated ine�cientlyfrequent conversion errors
SW (CU,IU) Contingent Capital JF 19 / 23
![Page 212: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/212.jpg)
The regulators’ concerns
Fed Governor Daniel Tarullo
It is unclear that CC for a going concern can be “structured soas to convert in a timely, reliable fashion.”
Financial Stability Oversight Council (FSOC)
“The loss absorption potential of a company’s capital structurecould be lower, because uncertainty may exist prior toconversion about whether instrument would actually convert tocommon equity in time to e↵ectively absorb losses.”
Death spiral
The negative e↵ect on price as the speculators create excessivepressure on the issuer’s stock price toward trigger or zeroFSOC warned the Congress that “market-based triggers canexacerbate the problem of death spiral.”
SW (CU,IU) Contingent Capital JF 20 / 23
![Page 213: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/213.jpg)
The regulators’ concerns
Fed Governor Daniel Tarullo
It is unclear that CC for a going concern can be “structured soas to convert in a timely, reliable fashion.”
Financial Stability Oversight Council (FSOC)
“The loss absorption potential of a company’s capital structurecould be lower, because uncertainty may exist prior toconversion about whether instrument would actually convert tocommon equity in time to e↵ectively absorb losses.”
Death spiral
The negative e↵ect on price as the speculators create excessivepressure on the issuer’s stock price toward trigger or zeroFSOC warned the Congress that “market-based triggers canexacerbate the problem of death spiral.”
SW (CU,IU) Contingent Capital JF 20 / 23
![Page 214: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/214.jpg)
The regulators’ concerns
Fed Governor Daniel Tarullo
It is unclear that CC for a going concern can be “structured soas to convert in a timely, reliable fashion.”
Financial Stability Oversight Council (FSOC)
“The loss absorption potential of a company’s capital structurecould be lower, because uncertainty may exist prior toconversion about whether instrument would actually convert tocommon equity in time to e↵ectively absorb losses.”
Death spiral
The negative e↵ect on price as the speculators create excessivepressure on the issuer’s stock price toward trigger or zeroFSOC warned the Congress that “market-based triggers canexacerbate the problem of death spiral.”
SW (CU,IU) Contingent Capital JF 20 / 23
![Page 215: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/215.jpg)
The regulators’ concerns
Fed Governor Daniel Tarullo
It is unclear that CC for a going concern can be “structured soas to convert in a timely, reliable fashion.”
Financial Stability Oversight Council (FSOC)
“The loss absorption potential of a company’s capital structurecould be lower, because uncertainty may exist prior toconversion about whether instrument would actually convert tocommon equity in time to e↵ectively absorb losses.”
Death spiral
The negative e↵ect on price as the speculators create excessivepressure on the issuer’s stock price toward trigger or zeroFSOC warned the Congress that “market-based triggers canexacerbate the problem of death spiral.”
SW (CU,IU) Contingent Capital JF 20 / 23
![Page 216: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/216.jpg)
The regulators’ concerns
Fed Governor Daniel Tarullo
It is unclear that CC for a going concern can be “structured soas to convert in a timely, reliable fashion.”
Financial Stability Oversight Council (FSOC)
“The loss absorption potential of a company’s capital structurecould be lower, because uncertainty may exist prior toconversion about whether instrument would actually convert tocommon equity in time to e↵ectively absorb losses.”
Death spiral
The negative e↵ect on price as the speculators create excessivepressure on the issuer’s stock price toward trigger or zeroFSOC warned the Congress that “market-based triggers canexacerbate the problem of death spiral.”
SW (CU,IU) Contingent Capital JF 20 / 23
![Page 217: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/217.jpg)
The regulators’ concerns
Fed Governor Daniel Tarullo
It is unclear that CC for a going concern can be “structured soas to convert in a timely, reliable fashion.”
Financial Stability Oversight Council (FSOC)
“The loss absorption potential of a company’s capital structurecould be lower, because uncertainty may exist prior toconversion about whether instrument would actually convert tocommon equity in time to e↵ectively absorb losses.”
Death spiral
The negative e↵ect on price as the speculators create excessivepressure on the issuer’s stock price toward trigger or zeroFSOC warned the Congress that “market-based triggers canexacerbate the problem of death spiral.”
SW (CU,IU) Contingent Capital JF 20 / 23
![Page 218: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/218.jpg)
The regulators’ concerns
Fed Governor Daniel Tarullo
It is unclear that CC for a going concern can be “structured soas to convert in a timely, reliable fashion.”
Financial Stability Oversight Council (FSOC)
“The loss absorption potential of a company’s capital structurecould be lower, because uncertainty may exist prior toconversion about whether instrument would actually convert tocommon equity in time to e↵ectively absorb losses.”
Death spiral
The negative e↵ect on price as the speculators create excessivepressure on the issuer’s stock price toward trigger or zero
FSOC warned the Congress that “market-based triggers canexacerbate the problem of death spiral.”
SW (CU,IU) Contingent Capital JF 20 / 23
![Page 219: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/219.jpg)
The regulators’ concerns
Fed Governor Daniel Tarullo
It is unclear that CC for a going concern can be “structured soas to convert in a timely, reliable fashion.”
Financial Stability Oversight Council (FSOC)
“The loss absorption potential of a company’s capital structurecould be lower, because uncertainty may exist prior toconversion about whether instrument would actually convert tocommon equity in time to e↵ectively absorb losses.”
Death spiral
The negative e↵ect on price as the speculators create excessivepressure on the issuer’s stock price toward trigger or zeroFSOC warned the Congress that “market-based triggers canexacerbate the problem of death spiral.”
SW (CU,IU) Contingent Capital JF 20 / 23
![Page 220: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/220.jpg)
Equilibrium in alternative market conditions
Di�culty in practical implementation
If there is no jump or bankruptcy costIf CC pays instantaneous risk-free rate until conversionThen Ct = mK/n = C is a unique equilibrium
Issue equity to avoid conversion?
Design CC to be always punitive (how?)If conversion is punitive, there can still be two equilibria
an equilibrium without conversion or issuancean equilibrium with issuance to avoid conversion
Practical CC contracts exclude this design
Financial distress cost makes the issue even worse
still have multiple equilibria in CC and equity valueseven multiple equilibria in firm and senior debt values
SW (CU,IU) Contingent Capital JF 21 / 23
![Page 221: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/221.jpg)
Equilibrium in alternative market conditions
Di�culty in practical implementation
If there is no jump or bankruptcy costIf CC pays instantaneous risk-free rate until conversionThen Ct = mK/n = C is a unique equilibrium
Issue equity to avoid conversion?
Design CC to be always punitive (how?)If conversion is punitive, there can still be two equilibria
an equilibrium without conversion or issuancean equilibrium with issuance to avoid conversion
Practical CC contracts exclude this design
Financial distress cost makes the issue even worse
still have multiple equilibria in CC and equity valueseven multiple equilibria in firm and senior debt values
SW (CU,IU) Contingent Capital JF 21 / 23
![Page 222: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/222.jpg)
Equilibrium in alternative market conditions
Di�culty in practical implementation
If there is no jump or bankruptcy cost
If CC pays instantaneous risk-free rate until conversionThen Ct = mK/n = C is a unique equilibrium
Issue equity to avoid conversion?
Design CC to be always punitive (how?)If conversion is punitive, there can still be two equilibria
an equilibrium without conversion or issuancean equilibrium with issuance to avoid conversion
Practical CC contracts exclude this design
Financial distress cost makes the issue even worse
still have multiple equilibria in CC and equity valueseven multiple equilibria in firm and senior debt values
SW (CU,IU) Contingent Capital JF 21 / 23
![Page 223: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/223.jpg)
Equilibrium in alternative market conditions
Di�culty in practical implementation
If there is no jump or bankruptcy costIf CC pays instantaneous risk-free rate until conversion
Then Ct = mK/n = C is a unique equilibrium
Issue equity to avoid conversion?
Design CC to be always punitive (how?)If conversion is punitive, there can still be two equilibria
an equilibrium without conversion or issuancean equilibrium with issuance to avoid conversion
Practical CC contracts exclude this design
Financial distress cost makes the issue even worse
still have multiple equilibria in CC and equity valueseven multiple equilibria in firm and senior debt values
SW (CU,IU) Contingent Capital JF 21 / 23
![Page 224: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/224.jpg)
Equilibrium in alternative market conditions
Di�culty in practical implementation
If there is no jump or bankruptcy costIf CC pays instantaneous risk-free rate until conversionThen Ct = mK/n = C is a unique equilibrium
Issue equity to avoid conversion?
Design CC to be always punitive (how?)If conversion is punitive, there can still be two equilibria
an equilibrium without conversion or issuancean equilibrium with issuance to avoid conversion
Practical CC contracts exclude this design
Financial distress cost makes the issue even worse
still have multiple equilibria in CC and equity valueseven multiple equilibria in firm and senior debt values
SW (CU,IU) Contingent Capital JF 21 / 23
![Page 225: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/225.jpg)
Equilibrium in alternative market conditions
Di�culty in practical implementation
If there is no jump or bankruptcy costIf CC pays instantaneous risk-free rate until conversionThen Ct = mK/n = C is a unique equilibrium
Issue equity to avoid conversion?
Design CC to be always punitive (how?)If conversion is punitive, there can still be two equilibria
an equilibrium without conversion or issuancean equilibrium with issuance to avoid conversion
Practical CC contracts exclude this design
Financial distress cost makes the issue even worse
still have multiple equilibria in CC and equity valueseven multiple equilibria in firm and senior debt values
SW (CU,IU) Contingent Capital JF 21 / 23
![Page 226: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/226.jpg)
Equilibrium in alternative market conditions
Di�culty in practical implementation
If there is no jump or bankruptcy costIf CC pays instantaneous risk-free rate until conversionThen Ct = mK/n = C is a unique equilibrium
Issue equity to avoid conversion?
Design CC to be always punitive (how?)
If conversion is punitive, there can still be two equilibria
an equilibrium without conversion or issuancean equilibrium with issuance to avoid conversion
Practical CC contracts exclude this design
Financial distress cost makes the issue even worse
still have multiple equilibria in CC and equity valueseven multiple equilibria in firm and senior debt values
SW (CU,IU) Contingent Capital JF 21 / 23
![Page 227: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/227.jpg)
Equilibrium in alternative market conditions
Di�culty in practical implementation
If there is no jump or bankruptcy costIf CC pays instantaneous risk-free rate until conversionThen Ct = mK/n = C is a unique equilibrium
Issue equity to avoid conversion?
Design CC to be always punitive (how?)If conversion is punitive, there can still be two equilibria
an equilibrium without conversion or issuancean equilibrium with issuance to avoid conversion
Practical CC contracts exclude this design
Financial distress cost makes the issue even worse
still have multiple equilibria in CC and equity valueseven multiple equilibria in firm and senior debt values
SW (CU,IU) Contingent Capital JF 21 / 23
![Page 228: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/228.jpg)
Equilibrium in alternative market conditions
Di�culty in practical implementation
If there is no jump or bankruptcy costIf CC pays instantaneous risk-free rate until conversionThen Ct = mK/n = C is a unique equilibrium
Issue equity to avoid conversion?
Design CC to be always punitive (how?)If conversion is punitive, there can still be two equilibria
an equilibrium without conversion or issuance
an equilibrium with issuance to avoid conversion
Practical CC contracts exclude this design
Financial distress cost makes the issue even worse
still have multiple equilibria in CC and equity valueseven multiple equilibria in firm and senior debt values
SW (CU,IU) Contingent Capital JF 21 / 23
![Page 229: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/229.jpg)
Equilibrium in alternative market conditions
Di�culty in practical implementation
If there is no jump or bankruptcy costIf CC pays instantaneous risk-free rate until conversionThen Ct = mK/n = C is a unique equilibrium
Issue equity to avoid conversion?
Design CC to be always punitive (how?)If conversion is punitive, there can still be two equilibria
an equilibrium without conversion or issuancean equilibrium with issuance to avoid conversion
Practical CC contracts exclude this design
Financial distress cost makes the issue even worse
still have multiple equilibria in CC and equity valueseven multiple equilibria in firm and senior debt values
SW (CU,IU) Contingent Capital JF 21 / 23
![Page 230: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/230.jpg)
Equilibrium in alternative market conditions
Di�culty in practical implementation
If there is no jump or bankruptcy costIf CC pays instantaneous risk-free rate until conversionThen Ct = mK/n = C is a unique equilibrium
Issue equity to avoid conversion?
Design CC to be always punitive (how?)If conversion is punitive, there can still be two equilibria
an equilibrium without conversion or issuancean equilibrium with issuance to avoid conversion
Practical CC contracts exclude this design
Financial distress cost makes the issue even worse
still have multiple equilibria in CC and equity valueseven multiple equilibria in firm and senior debt values
SW (CU,IU) Contingent Capital JF 21 / 23
![Page 231: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/231.jpg)
Equilibrium in alternative market conditions
Di�culty in practical implementation
If there is no jump or bankruptcy costIf CC pays instantaneous risk-free rate until conversionThen Ct = mK/n = C is a unique equilibrium
Issue equity to avoid conversion?
Design CC to be always punitive (how?)If conversion is punitive, there can still be two equilibria
an equilibrium without conversion or issuancean equilibrium with issuance to avoid conversion
Practical CC contracts exclude this design
Financial distress cost makes the issue even worse
still have multiple equilibria in CC and equity valueseven multiple equilibria in firm and senior debt values
SW (CU,IU) Contingent Capital JF 21 / 23
![Page 232: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/232.jpg)
Equilibrium in alternative market conditions
Di�culty in practical implementation
If there is no jump or bankruptcy costIf CC pays instantaneous risk-free rate until conversionThen Ct = mK/n = C is a unique equilibrium
Issue equity to avoid conversion?
Design CC to be always punitive (how?)If conversion is punitive, there can still be two equilibria
an equilibrium without conversion or issuancean equilibrium with issuance to avoid conversion
Practical CC contracts exclude this design
Financial distress cost makes the issue even worse
still have multiple equilibria in CC and equity values
even multiple equilibria in firm and senior debt values
SW (CU,IU) Contingent Capital JF 21 / 23
![Page 233: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/233.jpg)
Equilibrium in alternative market conditions
Di�culty in practical implementation
If there is no jump or bankruptcy costIf CC pays instantaneous risk-free rate until conversionThen Ct = mK/n = C is a unique equilibrium
Issue equity to avoid conversion?
Design CC to be always punitive (how?)If conversion is punitive, there can still be two equilibria
an equilibrium without conversion or issuancean equilibrium with issuance to avoid conversion
Practical CC contracts exclude this design
Financial distress cost makes the issue even worse
still have multiple equilibria in CC and equity valueseven multiple equilibria in firm and senior debt values
SW (CU,IU) Contingent Capital JF 21 / 23
![Page 234: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/234.jpg)
Regulatory decisions around the world
Basel
No CC in basic requirement (7%) or SIFI surcharge (0-2.5%)Regional regulators may allow CC for additional requirements
Trigger: � 7% for tier 1, plus regulatory triggerMaturity: perpetual for tier 1, � 5 years for tier 2Share issuance: must be capped
Switzerland’s FINMA
Requires SIFI to maintain at least 19% capital ratio10% equity, 3% “high-trigger” CC, 6% “low-trigger” CC
European Commission’s directives
4.5% equity, 1.5% “additional tier-1” CC, 2% tier 2 CCplus up to 7.5% surcharges, all common equity (no CC)
SW (CU,IU) Contingent Capital JF 22 / 23
![Page 235: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/235.jpg)
Regulatory decisions around the world
Basel
No CC in basic requirement (7%) or SIFI surcharge (0-2.5%)Regional regulators may allow CC for additional requirements
Trigger: � 7% for tier 1, plus regulatory triggerMaturity: perpetual for tier 1, � 5 years for tier 2Share issuance: must be capped
Switzerland’s FINMA
Requires SIFI to maintain at least 19% capital ratio10% equity, 3% “high-trigger” CC, 6% “low-trigger” CC
European Commission’s directives
4.5% equity, 1.5% “additional tier-1” CC, 2% tier 2 CCplus up to 7.5% surcharges, all common equity (no CC)
SW (CU,IU) Contingent Capital JF 22 / 23
![Page 236: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/236.jpg)
Regulatory decisions around the world
Basel
No CC in basic requirement (7%) or SIFI surcharge (0-2.5%)
Regional regulators may allow CC for additional requirements
Trigger: � 7% for tier 1, plus regulatory triggerMaturity: perpetual for tier 1, � 5 years for tier 2Share issuance: must be capped
Switzerland’s FINMA
Requires SIFI to maintain at least 19% capital ratio10% equity, 3% “high-trigger” CC, 6% “low-trigger” CC
European Commission’s directives
4.5% equity, 1.5% “additional tier-1” CC, 2% tier 2 CCplus up to 7.5% surcharges, all common equity (no CC)
SW (CU,IU) Contingent Capital JF 22 / 23
![Page 237: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/237.jpg)
Regulatory decisions around the world
Basel
No CC in basic requirement (7%) or SIFI surcharge (0-2.5%)Regional regulators may allow CC for additional requirements
Trigger: � 7% for tier 1, plus regulatory triggerMaturity: perpetual for tier 1, � 5 years for tier 2Share issuance: must be capped
Switzerland’s FINMA
Requires SIFI to maintain at least 19% capital ratio10% equity, 3% “high-trigger” CC, 6% “low-trigger” CC
European Commission’s directives
4.5% equity, 1.5% “additional tier-1” CC, 2% tier 2 CCplus up to 7.5% surcharges, all common equity (no CC)
SW (CU,IU) Contingent Capital JF 22 / 23
![Page 238: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/238.jpg)
Regulatory decisions around the world
Basel
No CC in basic requirement (7%) or SIFI surcharge (0-2.5%)Regional regulators may allow CC for additional requirements
Trigger: � 7% for tier 1, plus regulatory trigger
Maturity: perpetual for tier 1, � 5 years for tier 2Share issuance: must be capped
Switzerland’s FINMA
Requires SIFI to maintain at least 19% capital ratio10% equity, 3% “high-trigger” CC, 6% “low-trigger” CC
European Commission’s directives
4.5% equity, 1.5% “additional tier-1” CC, 2% tier 2 CCplus up to 7.5% surcharges, all common equity (no CC)
SW (CU,IU) Contingent Capital JF 22 / 23
![Page 239: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/239.jpg)
Regulatory decisions around the world
Basel
No CC in basic requirement (7%) or SIFI surcharge (0-2.5%)Regional regulators may allow CC for additional requirements
Trigger: � 7% for tier 1, plus regulatory triggerMaturity: perpetual for tier 1, � 5 years for tier 2
Share issuance: must be capped
Switzerland’s FINMA
Requires SIFI to maintain at least 19% capital ratio10% equity, 3% “high-trigger” CC, 6% “low-trigger” CC
European Commission’s directives
4.5% equity, 1.5% “additional tier-1” CC, 2% tier 2 CCplus up to 7.5% surcharges, all common equity (no CC)
SW (CU,IU) Contingent Capital JF 22 / 23
![Page 240: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/240.jpg)
Regulatory decisions around the world
Basel
No CC in basic requirement (7%) or SIFI surcharge (0-2.5%)Regional regulators may allow CC for additional requirements
Trigger: � 7% for tier 1, plus regulatory triggerMaturity: perpetual for tier 1, � 5 years for tier 2Share issuance: must be capped
Switzerland’s FINMA
Requires SIFI to maintain at least 19% capital ratio10% equity, 3% “high-trigger” CC, 6% “low-trigger” CC
European Commission’s directives
4.5% equity, 1.5% “additional tier-1” CC, 2% tier 2 CCplus up to 7.5% surcharges, all common equity (no CC)
SW (CU,IU) Contingent Capital JF 22 / 23
![Page 241: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/241.jpg)
Regulatory decisions around the world
Basel
No CC in basic requirement (7%) or SIFI surcharge (0-2.5%)Regional regulators may allow CC for additional requirements
Trigger: � 7% for tier 1, plus regulatory triggerMaturity: perpetual for tier 1, � 5 years for tier 2Share issuance: must be capped
Switzerland’s FINMA
Requires SIFI to maintain at least 19% capital ratio10% equity, 3% “high-trigger” CC, 6% “low-trigger” CC
European Commission’s directives
4.5% equity, 1.5% “additional tier-1” CC, 2% tier 2 CCplus up to 7.5% surcharges, all common equity (no CC)
SW (CU,IU) Contingent Capital JF 22 / 23
![Page 242: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/242.jpg)
Regulatory decisions around the world
Basel
No CC in basic requirement (7%) or SIFI surcharge (0-2.5%)Regional regulators may allow CC for additional requirements
Trigger: � 7% for tier 1, plus regulatory triggerMaturity: perpetual for tier 1, � 5 years for tier 2Share issuance: must be capped
Switzerland’s FINMA
Requires SIFI to maintain at least 19% capital ratio
10% equity, 3% “high-trigger” CC, 6% “low-trigger” CC
European Commission’s directives
4.5% equity, 1.5% “additional tier-1” CC, 2% tier 2 CCplus up to 7.5% surcharges, all common equity (no CC)
SW (CU,IU) Contingent Capital JF 22 / 23
![Page 243: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/243.jpg)
Regulatory decisions around the world
Basel
No CC in basic requirement (7%) or SIFI surcharge (0-2.5%)Regional regulators may allow CC for additional requirements
Trigger: � 7% for tier 1, plus regulatory triggerMaturity: perpetual for tier 1, � 5 years for tier 2Share issuance: must be capped
Switzerland’s FINMA
Requires SIFI to maintain at least 19% capital ratio10% equity, 3% “high-trigger” CC, 6% “low-trigger” CC
European Commission’s directives
4.5% equity, 1.5% “additional tier-1” CC, 2% tier 2 CCplus up to 7.5% surcharges, all common equity (no CC)
SW (CU,IU) Contingent Capital JF 22 / 23
![Page 244: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/244.jpg)
Regulatory decisions around the world
Basel
No CC in basic requirement (7%) or SIFI surcharge (0-2.5%)Regional regulators may allow CC for additional requirements
Trigger: � 7% for tier 1, plus regulatory triggerMaturity: perpetual for tier 1, � 5 years for tier 2Share issuance: must be capped
Switzerland’s FINMA
Requires SIFI to maintain at least 19% capital ratio10% equity, 3% “high-trigger” CC, 6% “low-trigger” CC
European Commission’s directives
4.5% equity, 1.5% “additional tier-1” CC, 2% tier 2 CCplus up to 7.5% surcharges, all common equity (no CC)
SW (CU,IU) Contingent Capital JF 22 / 23
![Page 245: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/245.jpg)
Regulatory decisions around the world
Basel
No CC in basic requirement (7%) or SIFI surcharge (0-2.5%)Regional regulators may allow CC for additional requirements
Trigger: � 7% for tier 1, plus regulatory triggerMaturity: perpetual for tier 1, � 5 years for tier 2Share issuance: must be capped
Switzerland’s FINMA
Requires SIFI to maintain at least 19% capital ratio10% equity, 3% “high-trigger” CC, 6% “low-trigger” CC
European Commission’s directives
4.5% equity, 1.5% “additional tier-1” CC, 2% tier 2 CC
plus up to 7.5% surcharges, all common equity (no CC)
SW (CU,IU) Contingent Capital JF 22 / 23
![Page 246: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/246.jpg)
Regulatory decisions around the world
Basel
No CC in basic requirement (7%) or SIFI surcharge (0-2.5%)Regional regulators may allow CC for additional requirements
Trigger: � 7% for tier 1, plus regulatory triggerMaturity: perpetual for tier 1, � 5 years for tier 2Share issuance: must be capped
Switzerland’s FINMA
Requires SIFI to maintain at least 19% capital ratio10% equity, 3% “high-trigger” CC, 6% “low-trigger” CC
European Commission’s directives
4.5% equity, 1.5% “additional tier-1” CC, 2% tier 2 CCplus up to 7.5% surcharges, all common equity (no CC)
SW (CU,IU) Contingent Capital JF 22 / 23
![Page 247: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/247.jpg)
Regulatory decisions around the world
U.K. Independent Commission on Banking
Does not endorse CC as regulatory toolEquity is the only form of loss-absorbing capacity that worksConcerned with the destabilizing e↵ects of CC
Canada (OFSI)
Does not endorse CC with early conversion featuresSupport convertible structured for resolution of failing banks
China: 11.5% equity and liquid capital, no CC
United States:
June ’12: Fed/OCC/FDIC proposed rules to implement Basel IIIJuly ’12: FSOC reported to the Congress
to discuss “a range of potential issues” of CCto recommend that contingent capital“remain an area for continued private sector innovation”
SW (CU,IU) Contingent Capital JF 23 / 23
![Page 248: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/248.jpg)
Regulatory decisions around the world
U.K. Independent Commission on Banking
Does not endorse CC as regulatory toolEquity is the only form of loss-absorbing capacity that worksConcerned with the destabilizing e↵ects of CC
Canada (OFSI)
Does not endorse CC with early conversion featuresSupport convertible structured for resolution of failing banks
China: 11.5% equity and liquid capital, no CC
United States:
June ’12: Fed/OCC/FDIC proposed rules to implement Basel IIIJuly ’12: FSOC reported to the Congress
to discuss “a range of potential issues” of CCto recommend that contingent capital“remain an area for continued private sector innovation”
SW (CU,IU) Contingent Capital JF 23 / 23
![Page 249: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/249.jpg)
Regulatory decisions around the world
U.K. Independent Commission on Banking
Does not endorse CC as regulatory tool
Equity is the only form of loss-absorbing capacity that worksConcerned with the destabilizing e↵ects of CC
Canada (OFSI)
Does not endorse CC with early conversion featuresSupport convertible structured for resolution of failing banks
China: 11.5% equity and liquid capital, no CC
United States:
June ’12: Fed/OCC/FDIC proposed rules to implement Basel IIIJuly ’12: FSOC reported to the Congress
to discuss “a range of potential issues” of CCto recommend that contingent capital“remain an area for continued private sector innovation”
SW (CU,IU) Contingent Capital JF 23 / 23
![Page 250: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/250.jpg)
Regulatory decisions around the world
U.K. Independent Commission on Banking
Does not endorse CC as regulatory toolEquity is the only form of loss-absorbing capacity that works
Concerned with the destabilizing e↵ects of CC
Canada (OFSI)
Does not endorse CC with early conversion featuresSupport convertible structured for resolution of failing banks
China: 11.5% equity and liquid capital, no CC
United States:
June ’12: Fed/OCC/FDIC proposed rules to implement Basel IIIJuly ’12: FSOC reported to the Congress
to discuss “a range of potential issues” of CCto recommend that contingent capital“remain an area for continued private sector innovation”
SW (CU,IU) Contingent Capital JF 23 / 23
![Page 251: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/251.jpg)
Regulatory decisions around the world
U.K. Independent Commission on Banking
Does not endorse CC as regulatory toolEquity is the only form of loss-absorbing capacity that worksConcerned with the destabilizing e↵ects of CC
Canada (OFSI)
Does not endorse CC with early conversion featuresSupport convertible structured for resolution of failing banks
China: 11.5% equity and liquid capital, no CC
United States:
June ’12: Fed/OCC/FDIC proposed rules to implement Basel IIIJuly ’12: FSOC reported to the Congress
to discuss “a range of potential issues” of CCto recommend that contingent capital“remain an area for continued private sector innovation”
SW (CU,IU) Contingent Capital JF 23 / 23
![Page 252: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/252.jpg)
Regulatory decisions around the world
U.K. Independent Commission on Banking
Does not endorse CC as regulatory toolEquity is the only form of loss-absorbing capacity that worksConcerned with the destabilizing e↵ects of CC
Canada (OFSI)
Does not endorse CC with early conversion featuresSupport convertible structured for resolution of failing banks
China: 11.5% equity and liquid capital, no CC
United States:
June ’12: Fed/OCC/FDIC proposed rules to implement Basel IIIJuly ’12: FSOC reported to the Congress
to discuss “a range of potential issues” of CCto recommend that contingent capital“remain an area for continued private sector innovation”
SW (CU,IU) Contingent Capital JF 23 / 23
![Page 253: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/253.jpg)
Regulatory decisions around the world
U.K. Independent Commission on Banking
Does not endorse CC as regulatory toolEquity is the only form of loss-absorbing capacity that worksConcerned with the destabilizing e↵ects of CC
Canada (OFSI)
Does not endorse CC with early conversion features
Support convertible structured for resolution of failing banks
China: 11.5% equity and liquid capital, no CC
United States:
June ’12: Fed/OCC/FDIC proposed rules to implement Basel IIIJuly ’12: FSOC reported to the Congress
to discuss “a range of potential issues” of CCto recommend that contingent capital“remain an area for continued private sector innovation”
SW (CU,IU) Contingent Capital JF 23 / 23
![Page 254: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/254.jpg)
Regulatory decisions around the world
U.K. Independent Commission on Banking
Does not endorse CC as regulatory toolEquity is the only form of loss-absorbing capacity that worksConcerned with the destabilizing e↵ects of CC
Canada (OFSI)
Does not endorse CC with early conversion featuresSupport convertible structured for resolution of failing banks
China: 11.5% equity and liquid capital, no CC
United States:
June ’12: Fed/OCC/FDIC proposed rules to implement Basel IIIJuly ’12: FSOC reported to the Congress
to discuss “a range of potential issues” of CCto recommend that contingent capital“remain an area for continued private sector innovation”
SW (CU,IU) Contingent Capital JF 23 / 23
![Page 255: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/255.jpg)
Regulatory decisions around the world
U.K. Independent Commission on Banking
Does not endorse CC as regulatory toolEquity is the only form of loss-absorbing capacity that worksConcerned with the destabilizing e↵ects of CC
Canada (OFSI)
Does not endorse CC with early conversion featuresSupport convertible structured for resolution of failing banks
China: 11.5% equity and liquid capital, no CC
United States:
June ’12: Fed/OCC/FDIC proposed rules to implement Basel IIIJuly ’12: FSOC reported to the Congress
to discuss “a range of potential issues” of CCto recommend that contingent capital“remain an area for continued private sector innovation”
SW (CU,IU) Contingent Capital JF 23 / 23
![Page 256: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/256.jpg)
Regulatory decisions around the world
U.K. Independent Commission on Banking
Does not endorse CC as regulatory toolEquity is the only form of loss-absorbing capacity that worksConcerned with the destabilizing e↵ects of CC
Canada (OFSI)
Does not endorse CC with early conversion featuresSupport convertible structured for resolution of failing banks
China: 11.5% equity and liquid capital, no CC
United States:
June ’12: Fed/OCC/FDIC proposed rules to implement Basel IIIJuly ’12: FSOC reported to the Congress
to discuss “a range of potential issues” of CCto recommend that contingent capital“remain an area for continued private sector innovation”
SW (CU,IU) Contingent Capital JF 23 / 23
![Page 257: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/257.jpg)
Regulatory decisions around the world
U.K. Independent Commission on Banking
Does not endorse CC as regulatory toolEquity is the only form of loss-absorbing capacity that worksConcerned with the destabilizing e↵ects of CC
Canada (OFSI)
Does not endorse CC with early conversion featuresSupport convertible structured for resolution of failing banks
China: 11.5% equity and liquid capital, no CC
United States:
June ’12: Fed/OCC/FDIC proposed rules to implement Basel III
July ’12: FSOC reported to the Congress
to discuss “a range of potential issues” of CCto recommend that contingent capital“remain an area for continued private sector innovation”
SW (CU,IU) Contingent Capital JF 23 / 23
![Page 258: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/258.jpg)
Regulatory decisions around the world
U.K. Independent Commission on Banking
Does not endorse CC as regulatory toolEquity is the only form of loss-absorbing capacity that worksConcerned with the destabilizing e↵ects of CC
Canada (OFSI)
Does not endorse CC with early conversion featuresSupport convertible structured for resolution of failing banks
China: 11.5% equity and liquid capital, no CC
United States:
June ’12: Fed/OCC/FDIC proposed rules to implement Basel IIIJuly ’12: FSOC reported to the Congress
to discuss “a range of potential issues” of CCto recommend that contingent capital“remain an area for continued private sector innovation”
SW (CU,IU) Contingent Capital JF 23 / 23
![Page 259: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/259.jpg)
Regulatory decisions around the world
U.K. Independent Commission on Banking
Does not endorse CC as regulatory toolEquity is the only form of loss-absorbing capacity that worksConcerned with the destabilizing e↵ects of CC
Canada (OFSI)
Does not endorse CC with early conversion featuresSupport convertible structured for resolution of failing banks
China: 11.5% equity and liquid capital, no CC
United States:
June ’12: Fed/OCC/FDIC proposed rules to implement Basel IIIJuly ’12: FSOC reported to the Congress
to discuss “a range of potential issues” of CC
to recommend that contingent capital“remain an area for continued private sector innovation”
SW (CU,IU) Contingent Capital JF 23 / 23
![Page 260: On the Design of Contingent Capital · 2018-04-03 · Basic idea of contingent capital (CC) The capital functions as a debt in a good state/bank It has a par value, which is the initial](https://reader033.vdocument.in/reader033/viewer/2022060309/5f0a69937e708231d42b81fc/html5/thumbnails/260.jpg)
Regulatory decisions around the world
U.K. Independent Commission on Banking
Does not endorse CC as regulatory toolEquity is the only form of loss-absorbing capacity that worksConcerned with the destabilizing e↵ects of CC
Canada (OFSI)
Does not endorse CC with early conversion featuresSupport convertible structured for resolution of failing banks
China: 11.5% equity and liquid capital, no CC
United States:
June ’12: Fed/OCC/FDIC proposed rules to implement Basel IIIJuly ’12: FSOC reported to the Congress
to discuss “a range of potential issues” of CCto recommend that contingent capital“remain an area for continued private sector innovation”
SW (CU,IU) Contingent Capital JF 23 / 23