Europe's CoCos Provide a Lesson on Uncertainty

32 Pages Posted: 9 May 2017

See all articles by Katherine Gleason

Katherine Gleason

Government of the United States of America - Office of Financial Research

Steve Bright

Government of the United States of America - Office of Financial Research

Francis Martinez

Board of Governors of the Federal Reserve System

Charles Taylor

Government of the United States of America - Office of Financial Research

Date Written: April 5, 2017

Abstract

Contingent convertible bonds (CoCos) issued by European global systemically important banks (GSIBs) as part of their total loss-absorbing capacity (TLAC) are meant to enhance financial stability by forcing investors to absorb losses when a bank is under stress. Coupon payments are made at issuers’ discretion while loss absorption can be triggered at regulators’ discretion. This study investigates price effects of four press releases by Deutsche Bank AG in February 2016 related to the bank’s willingness and ability to make its upcoming CoCo coupon payments. Expected cash flow models capture changes in CoCo default risk, while event dates capture uncertainty effects. The price of a European G-SIB peer group portfolio declined a statistically significant 2.0-2.5 percent over two days in response to Deutsche Bank’s first press release. Deutsche Bank’s efforts to allay its own CoCo investors’ concerns appeared to increase concerns among CoCo investors generally. The results show potential negative effects of regulatory discretion.

Keywords: Banking, Regulation, Capital, Modeling, Risk, Uncertainty

JEL Classification: G12, G14, G21, G23, G28

Suggested Citation

Gleason, Katherine and Bright, Steve and Martinez, Francis and Taylor, Charles, Europe's CoCos Provide a Lesson on Uncertainty (April 5, 2017). OFR WP 17-02, Available at SSRN: https://ssrn.com/abstract=2965085 or http://dx.doi.org/10.2139/ssrn.2965085

Katherine Gleason (Contact Author)

Government of the United States of America - Office of Financial Research ( email )

717 14th Street, NW
Washington DC, DC 20005
United States

Steve Bright

Government of the United States of America - Office of Financial Research ( email )

717 14th Street, NW
Washington DC, DC 20005
United States

Francis Martinez

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Charles Taylor

Government of the United States of America - Office of Financial Research ( email )

717 14th Street, NW
Washington DC, DC 20005
United States

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