Contingent convertible bonds for sovereign debt risk management

The Wharton Financial Institutions Center WP 15-13, in print Journal of Globalization and Development.

32 Pages Posted: 26 Nov 2015 Last revised: 20 Oct 2018

See all articles by Andrea Consiglio

Andrea Consiglio

University of Palermo - d/SEAS

Stavros A. Zenios

University of Cyprus; Bruegel; University of Pennsylvania - Wharton Financial Institutions Center

Date Written: November 1, 2015

Abstract

We consider convertible bonds that contractually stipulate payment standstill, contingent on a market indicator of a sovereign's creditworthiness breaching a distress threshold. This financial innovation limits ex-ante the likelihood of debt crises and imposes ex-post risk sharing between creditors and the debtor. Drawing from literature on contingent contracts, neglected risks, and bank CoCo, we extend prevailing arguments in favor of sovereign CoCo (S-CoCo). We discuss issues relating to their design: which market trigger, market discipline and sovereign incentives, and errors of false alarms or missed crises, and provide supporting evidence with eurozone data and a simple simulation on the use of S-CoCo. We develop a risk management model using these instruments to trade off the expected cost for sovereign financing over a long horizon, with tail risk. The model shows how contingent bonds can improve a country's debt risk profile. Using Greece as a case study the model illustrates improvements in expected cost vs tail risk for the country when using contingent debt.

Keywords: Contingent debt, sovereign crises, CDS spreads, debt restructuring, pricing, risk management, banking

JEL Classification: C61, C63, D61,E3, E47, E62, F34, G21, G38, H63

Suggested Citation

Consiglio, Andrea and Zenios, Stavros A., Contingent convertible bonds for sovereign debt risk management (November 1, 2015). The Wharton Financial Institutions Center WP 15-13, in print Journal of Globalization and Development.. Available at SSRN: https://ssrn.com/abstract=2694973 or http://dx.doi.org/10.2139/ssrn.2694973

Andrea Consiglio

University of Palermo - d/SEAS ( email )

Viale delle Scienze, edificio 13
Palermo, 90124
Italy

HOME PAGE: http://portale.unipa.it/persone/docenti/c/andrea.consiglio

Stavros A. Zenios (Contact Author)

University of Cyprus ( email )

75 Kallipoleos Street
P.O. Box 20537
Nicosia CY-1678
Cyprus
+357 2 893605 (Phone)

HOME PAGE: http://https://www.researchgate.net/profile/Stavros_Zenios

Bruegel ( email )

Rue de la Charité 33
B-1210 Brussels Belgium, 1210
Belgium

University of Pennsylvania - Wharton Financial Institutions Center ( email )

3733 Spruce Street
Philadelphia, PA 19104-6374
United States

HOME PAGE: http://zenios.wordpress.com

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