Numerical Pricing of Coco Bonds with Parisian Trigger Feature Using the Fortet Method

Posted: 9 Sep 2015 Last revised: 7 Aug 2017

See all articles by Chi Man Leung

Chi Man Leung

Hong Kong University of Science & Technology (HKUST)

Yue Kuen Kwok

Hong Kong University of Science & Technology - Department of Mathematics

Date Written: September 9, 2015

Abstract

Unlike conventional convertible bonds, contingent convertible (CoCo) bonds are converted into equity shares of the issuing bank subject to certain trigger mechanisms (accounting and/or regulatory trigger) when the issuing bank is under financial non-viable state. We consider pricing of these CoCos using the contingent claims approach, where the state variables are the stock price and Tier 1 capital ratio. We use the Parisian feature to model the regulatory trigger where equity conversion is triggered when the capital ratio stays under the non-viable state cumulatively for a certain period of time. The accounting trigger is modeled using the one-touch barrier feature associated with the capital ratio. The Parisian trigger feature adds one extra path dependent state variable in the pricing model of a CoCo bond. We design effective numerical algorithms for pricing the Coco bonds using the extended Fortet method that avoid the issuance of adding one state variable for the Parisian feature of regulatory trigger. Pricing properties of the CoCo bonds under both regulatory trigger and accounting trigger are explored.

Keywords: Coco bonds, conversion triggers, Parisian feature, Fortet method

JEL Classification: G30

Suggested Citation

Leung, Chi Man and Kwok, Yue Kuen, Numerical Pricing of Coco Bonds with Parisian Trigger Feature Using the Fortet Method (September 9, 2015). Available at SSRN: https://ssrn.com/abstract=2657991 or http://dx.doi.org/10.2139/ssrn.2657991

Chi Man Leung

Hong Kong University of Science & Technology (HKUST) ( email )

Clear Water Bay
Hong Kong

Yue Kuen Kwok (Contact Author)

Hong Kong University of Science & Technology - Department of Mathematics ( email )

Clearwater Bay
Kowloon, 999999
Hong Kong

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