Structural Pricing of CoCos and Deposit Insurance with Regime Switching and Jumps

Asia-Pacific Financial Markets Vol. 27, N°4, p. 477–520, 2020

42 Pages Posted: 19 Jan 2018 Last revised: 2 Dec 2020

See all articles by Olivier Le Courtois

Olivier Le Courtois

EM Lyon (Ecole de Management de Lyon) - Department of Economics, Finance, Control

Xiaoshan Su

Beihang University (BUAA)

Date Written: February 11, 2018

Abstract

In this article, we construct a structural model with jumps and regime switching to price banks' contingent convertible debt (CoCos) and deposit insurance. We use an Esscher transform that is applicable to regime switching double exponential jump diffusions to move from the historical world to the risk-neutral world. Further, we define and implement a matrix Wiener-Hopf factorization associated with the latter processes, allowing us to price the various components of a bank's balance sheet. Thus, we obtain valuation formulas for the bank's equity, debt, deposits, CoCos, and deposit insurance. We also show in an illustration the respective effects of the jump risk and of regime switching on the values of all of a bank's balance sheet components.

Keywords: Structural model; Regime switching; Jump-diffusion; Matrix Wiener-Hopf factorization; Esscher transform; CoCos; Deposit insurance; Fluid embedding; Markov chain

JEL Classification: G13; G21; G32

Suggested Citation

Le Courtois, Olivier Arnaud and Su, Xiaoshan, Structural Pricing of CoCos and Deposit Insurance with Regime Switching and Jumps (February 11, 2018). Asia-Pacific Financial Markets Vol. 27, N°4, p. 477–520, 2020, Available at SSRN: https://ssrn.com/abstract=3105237 or http://dx.doi.org/10.2139/ssrn.3105237

Olivier Arnaud Le Courtois (Contact Author)

EM Lyon (Ecole de Management de Lyon) - Department of Economics, Finance, Control ( email )

23, av. Guy de Collongue
69134 Ecully Cedex
France

Xiaoshan Su

Beihang University (BUAA) ( email )

37 Xue Yuan Road
Beijing 100083
China

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