A Tough Nut to Crack: On the Pricing of Capital Ratio Triggered Contingent Convertibles

Abstract

Although the first contingent convertibles (CoCo) have already been issued in 2009, the pricing of such securities has not attracted much attention from the academic community so far. Combining various aspects from existing theoretical and practical literature, this paper presents a CoCo pricing methodology, which allows the valuation of equity or TIER-1 ratio triggered CoCos in a comprehensible way. The model is based upon the assumption that the issuer’s total asset value follows a Brownian motion, book values reflecting fair economic values in the case of financial distress and the existence of a linear relationship between straight equity and TIER-1 ratios. The pricing methodology then is applied to the Credit Suisse BCN issued in February 2011, which depicts that the pricing of CoCos in practice is afflicted with a degree of uncertainty that is not to be underestimated.

Keywords: Contingent convertible, Pricing, Capital ratio trigger

JEL Classification: G12, G13, G18, G21