Contingent Capital: An In-Depth Discussion

23 Pages Posted: 6 Aug 2010 Last revised: 28 Aug 2010

Stan Maes

European Commission - DG Internal market and financial services; European Commission - DG Competition; KU Leuven - Department of Economics

Wim Schoutens

KU Leuven - Department of Mathematics

Date Written: August 2, 2010

Abstract

Regulators have embraced the idea of pre-arranging bank recapitalizations through (funded or unfunded) contingent capital issuance. Contingent capital is intended to be triggered when a bank is headed toward failure in order to provide an automatic equity injection that keeps the bank out of distress. This note discusses counterparty risk, effectiveness, moral hazard, contagion and systemic risk, as well as death-spiral issues arising from the hedging strategies of the investors. We pay attention to important design issues with respect to the trigger and conversion ratio and comment on their pricing from an equity and credit derivative perspective.

Keywords: Contingent Capital, Moral Hazard, Financial Regulation

JEL Classification: G12, G13, G21, G28, G32

Suggested Citation

Maes, Stan and Schoutens, Wim, Contingent Capital: An In-Depth Discussion (August 2, 2010). Available at SSRN: https://ssrn.com/abstract=1653877 or http://dx.doi.org/10.2139/ssrn.1653877

Konstantijn Maes

European Commission - DG Internal market and financial services ( email )

Rue de la Loi 200
Brussels, B-1049
Belgium

European Commission - DG Competition ( email )

Place Madou, Madouplein 1
Saint-Josse-ten-Noode/Sint-Joost-ten-Noode
Brussels, B-1049
Belgium

KU Leuven - Department of Economics ( email )

Naamsestraat 69
2nd Floor
B-3000 Leuven
Belgium

HOME PAGE: http://www.econ.kuleuven.ac.be/ew/academic/intecon

Wim Schoutens (Contact Author)

KU Leuven - Department of Mathematics ( email )

Celestijnenlaan 200 B
Leuven, B-3001
Belgium

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