Contingent Capital: The Case for COERCs
University of Illinois
INSEAD - Finance
Christian C. P. Wolff
University of Luxembourg - Luxembourg School of Finance; Centre for Economic Policy Research (CEPR)
CEPR Discussion Paper No. DP8028
In this paper we propose a new security, the Call Option Enhanced Reverse Convertible (COERC). The security is a form of contingent capital, i.e. a bond that converts into equity when the market value of equity relative to debt falls below a certain trigger. The conversion price is set significantly below the trigger price and, at the same time, equity holders have the option to buy back the shares from the bondholders at the conversion price. Compared to other forms of contingent capital proposed in the literature, the COERC is less risky in a world where bank assets can experience sudden jumps. Moreover, the structure eliminates concerns about putting the company in a death spiral as a result of manipulation or panic. A bank that issues COERCs also has a smaller incentive to choose investments that are subject to large losses.
Number of Pages in PDF File: 46
Keywords: Banks, Financial crisis, Financial stability, Security design
JEL Classification: G01, G20working papers series
Date posted: November 22, 2010
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