Pricing CoCos with a Market Trigger

Abstract

Contingent Convertible Bonds, or CoCos, are contingent capital instruments which are converted into shares, or may suffer a principal write-down, if certain trigger event occurs. In this paper we discuss some approaches to the problem of pricing CoCos when its conversion and the other relevant credit events are triggered by the issuer's share price. We introduce a new model of partial information which aims at enhancing the market trigger approach while remaining analytically tractable. We address also CoCos having the additional feature of being callable by the issuer at a series of pre-defined dates. These callable CoCos are thus exposed to a new source of risk - referred to as extension risk - since they have no fixed maturity, and the repayment of the principal may take place at the issuer's convenience.

Keywords: Contingent Convertibles, Market triggers, Short-term uncertainty, Extension Risk

JEL Classification: G11, G12, G13, G18, G21, G32