An Experimental Analysis of Contingent Capital Triggering Mechanisms

42 Pages Posted: 18 Dec 2012

See all articles by Douglas D. Davis

Douglas D. Davis

Virginia Commonwealth University - School of Business - Department of Economics

Oleg Korenok

Virginia Commonwealth University - School of Business

Edward S. Prescott

Federal Reserve Banks - Federal Reserve Bank of Cleveland

Date Written: October 4, 2011

Abstract

This paper reports an experiment that evaluates three regimes for triggering the conversion of contingent capital bonds into equity: (a) a “regulator” regime, where socially motivated regulators make conversion decisions based on observed prices, (b) a “fixed trigger” regime where a price threshold triggers a mandatory conversion, and (c) a “prediction market” regime where we supplement the regulator’s information set with the results of a prediction market that elicits traders’ perceived likelihood of a conversion. Consistent with theory, we observe informational and allocative inefficiencies as well as numerous errors in conversion decisions in both the regulator and fixed trigger regimes. Contrary to theory, however, we also observe inefficiencies and frequent conversion errors in the prediction market regime. Although the fixed trigger and prediction market regimes are more informationally efficient than the regulator regime, allocative efficiencies remain low and conversion error rates high in all three regimes.

Keywords: bank regulation, experiments, contingent capital

JEL Classification: C92, G14, G28

Suggested Citation

Davis, Douglas D. and Korenok, Oleg and Prescott, Edward (Ned) Simpson, An Experimental Analysis of Contingent Capital Triggering Mechanisms (October 4, 2011). FRB Richmond Working Paper No. 11-01R. Available at SSRN: https://ssrn.com/abstract=2190618 or http://dx.doi.org/10.2139/ssrn.2190618

Douglas D. Davis

Virginia Commonwealth University - School of Business - Department of Economics ( email )

Box 844000
Richmond, VA 23284-4000
United States

Oleg Korenok

Virginia Commonwealth University - School of Business ( email )

1015 Floyd Avenue
Richmond, VA 23284-4000
United States

Edward (Ned) Simpson Prescott (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Cleveland ( email )

P.O. Box 6387
Cleveland, OH 44101
United States

HOME PAGE: http://https://www.clevelandfed.org/people-search?pid=f8ca941e-4b51-41f6-95f8-c87f1d3806e5

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