Are Banks Now Safer? What Can We Learn from the CoCo Markets?
6 Pages Posted: 21 Aug 2015
Date Written: August 20, 2015
Contingent Convertible bonds or CoCos are loss absorbing hybrid instruments.CoCos can be seen as derivative instruments contingent on the CET1 level. Hence one can, using some standard models, infer from observed market prices of CoCos implied CET1 volatility levels. Recent regulatory reforms have urged banks to increase their CET1 levels and many banks have clearly done so. However, if one calculates the implied CET1 volatilities either on the basis of the contractual accounting CoCo trigger or even on an estimated PoNV trigger level, one sees also a significant increase in the CET1 volatility levels over the same period of time. The average level of the CET1 has been rising, but also the volatility or standard deviation of that level, indicating that a higher CET1 level not necessarily implies that banks have become safer. Bank’s capital levels are higher but have become also much more volatile.
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