What's the Contingency? A Proposal for Bank Contingent Capital Triggered by Systemic Risk

43 Pages Posted: 25 Oct 2014 Last revised: 26 May 2016

See all articles by Linda Allen

Linda Allen

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance

Yi Tang

Fordham University - Gabelli School of Business

Multiple version iconThere are 3 versions of this paper

Date Written: May 2016

Abstract

Contingent capital (coco) automatically recapitalizes the banking system during financial crises if the trigger mechanism is properly designed. We propose a dual trigger mechanism based on: (1) aggregate systemic risk in the banking system, measured using CATFIN, and (2) the individual bank’s contribution to overall systemic risk, measured using delta CoVaR. The dual trigger is highly correlated with system-wide insolvency risk and prices systemic risk. We set different triggers for banks, insurance companies and broker-dealers. Using the 99% cut-off, systemic coco issued by Lehman and Bear Stearns would have been triggered in November 2007, months prior to their actual demise.

Keywords: contingent capital, callable put option, dual trigger exercise price, systemic risk

JEL Classification: G21, E58

Suggested Citation

Allen, Linda and Tang, Yi, What's the Contingency? A Proposal for Bank Contingent Capital Triggered by Systemic Risk (May 2016). Available at SSRN: https://ssrn.com/abstract=2514500 or http://dx.doi.org/10.2139/ssrn.2514500

Linda Allen (Contact Author)

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance ( email )

17 Lexington Avenue
New York, NY 10010
United States
646-312-3463 (Phone)
646-312-3451 (Fax)

HOME PAGE: http://stern.nyu.edu/~lallen

Yi Tang

Fordham University - Gabelli School of Business ( email )

113 West 60th Street
New York, NY 10023
United States

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