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Pricing and Hedging CoCos

Patrick Cheridito

ETH Zurich

Zhikai Xu

AQR Capital Management, LLC

April 2015

Contingent convertible bonds are typical hybrid products in that they are exposed to different types of risk: interest rate risk, equity risk and conversion risk. We first develop a general framework for their pricing and hedging that can be specified in different ways. Then we focus on intensity-based and first-passage time models driven by a finite-dimensional Markov process. The two approaches are qualitatively different. But both allow to price contingent convertibles and calculate dynamic hedging strategies with holdings in related instruments such as fixed income products, the issuing company's stock and credit default swaps. As case studies we consider contingent convertibles issued by Lloyds Banking Group in December of 2009 and Rabobank in March of 2010.

Number of Pages in PDF File: 27

Keywords: Contingent convertible bonds, credit default swaps, pricing, calibration, hedging, intensity-based model, first-passage time model

JEL Classification: G12, G13

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Date posted: January 17, 2013 ; Last revised: April 9, 2015

Suggested Citation

Cheridito, Patrick and Xu, Zhikai, Pricing and Hedging CoCos (April 2015). Available at SSRN: https://ssrn.com/abstract=2201364 or http://dx.doi.org/10.2139/ssrn.2201364

Contact Information

Patrick Cheridito (Contact Author)
ETH Zurich ( email )
Department of Mathematics
8092 Zurich

Zhikai Xu
AQR Capital Management, LLC
Greenwich, CT
United States

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