CoCo Bonds with Extension Risk

33 Pages Posted: 5 Feb 2014

See all articles by Jan De Spiegeleer

Jan De Spiegeleer


Wim Schoutens

KU Leuven - Department of Mathematics

Date Written: February 3, 2014


This article provides an in-depth analysis of the pricing and structuring of contingent convertibles (CoCos) with extension risk. Under the new regulatory Basel III framework, CoCo bonds can be categorised as either belonging to the Additional Tier 1 or Tier 2 capital category. The Tier 1 CoCo bonds have cancellable coupons and do not have a predefined maturity. In addition, they contain no incentive, such as a coupon step-up, for the issuer to redeem at the first call date. This is in sharp contrast with the old-style hybrid bonds issued by financial institution before the 2008 financial crisis. At that time, banks issued callable bonds with a coupon-step up after the first call date. These bonds were categorised as additional Tier 1 and their step-up feature reduced the probability that the bank skipped the call and kept the bond alive. The existence of the coupon step up was considered by a lot of practitioners as a justification to categorise those bonds as fixed maturity bonds that expire on the first call date. The fact that coupon step-ups are no longer allowed in the new regulatory framework, forces us to think differently when dealing with Tier 1 bonds. We explain how to integrate this extension risk into a valuation method for CoCo bonds.

Keywords: contingent capital, CoCo bonds, extension risk, bail-in, additional Tier 1, Tier 2

JEL Classification: G12, G13, G18, G21, G28, G32

Suggested Citation

De Spiegeleer, Jan and Schoutens, Wim, CoCo Bonds with Extension Risk (February 3, 2014). Available at SSRN: or

Jan De Spiegeleer (Contact Author)

RiskConcile ( email )

Kapeldreef 60
Leuven, 3000
492227143 (Phone)


Wim Schoutens

KU Leuven - Department of Mathematics ( email )

Celestijnenlaan 200 B
Leuven, B-3001

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