Contingent Conversion Convertible Bond: New Avenue to Raise Bank Capital

22 Pages Posted: 5 Jan 2013

See all articles by Francesca Di Girolamo

Francesca Di Girolamo

Joint Research Centre, Italy

Francesca Campolongo

Europoean Commission - Joint Reserach Centre; European Commission Joint Research Center

Jan De Spiegeleer

RiskConcile

Wim Schoutens

KU Leuven - Department of Mathematics

Date Written: October 31, 2012

Abstract

This paper provides an in-depth analysis into the structuring and the pricing of an innovative financial market product. This instrument is called contingent conversion convertible bond or "CoCoCo". This hybrid bond is itself a combination of two other hybrid instruments: a contingent convertible ("CoCo") and a convertible bond. This combination introduces more complexity in the structure but it now allows investors to profit from strong share price performances.

This upside potential is added on top of the normal contingent convertible mechanics whereas CoCos only expose the investors to downside risk. This sets up a new avenue for the banks to create new capital.

First, we explain how the features of the contingent convertible bonds on one side and the features of the standard convertible bonds on the other side are combined. Thereafter, we propose a pricing approach which moves away from the standard Black & Scholes setting. The CoCoCos are evaluated using the Heston process to which a Hull-White interest rate process has been added. We demonstrate the importance of using a stochastic interest rate when modeling this instrument. Finally we quantify the loss absorbing capacity of this instrument.

Keywords: G13, G18, G21, C15

JEL Classification: Convertible bonds, Contingent convertible bonds, Monte Carlo simulations, Sensitivity analysis

Suggested Citation

Di Girolamo, Francesca and Campolongo, Francesca and De Spiegeleer, Jan and Schoutens, Wim, Contingent Conversion Convertible Bond: New Avenue to Raise Bank Capital (October 31, 2012). Available at SSRN: https://ssrn.com/abstract=2196339 or http://dx.doi.org/10.2139/ssrn.2196339

Francesca Di Girolamo (Contact Author)

Joint Research Centre, Italy ( email )

Via E. Fermi 1
I-21020 Ispra (VA)
United States

Francesca Campolongo

Europoean Commission - Joint Reserach Centre ( email )

Rue de la Loi 200
Brussels, B-1049
Belgium

European Commission Joint Research Center ( email )

1049
Belgium

Jan De Spiegeleer

RiskConcile ( email )

Kapeldreef 60
Leuven, 3000
Belgium
492227143 (Phone)

HOME PAGE: http://www.riskconcile.com

Wim Schoutens

KU Leuven - Department of Mathematics ( email )

Celestijnenlaan 200 B
Leuven, B-3001
Belgium

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