Accounting Noise and the Pricing of Cocos

Tinbergen Institute Discussion Paper 2018-037/VI

44 Pages Posted: 2 May 2018

See all articles by Mike Derksen

Mike Derksen

University of Amsterdam - Korteweg-de Vries Institute for Mathematics

Peter Spreij

Universiteit van Amsterdam, Korteweg-de Vries Institute for Mathematics

Sweder van Wijnbergen

Universiteit van Amsterdam; Tinbergen Institute; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: April 8, 2018

Abstract

Contingent Convertible bonds (CoCos) are debt instruments that convert into equity or are written down in times of distress. Existing pricing models assume conversion triggers based on market prices and on the assumption that markets can always observe all relevant firm information. But all Cocos issued so far have triggers based on accounting ratios and/or regulatory intervention. We incorporate that markets receive information through noisy accounting reports issued at discrete time instants, which allows us to distinguish between market and accounting values, and between automatic triggers and regulator-mandated conversions. Our second contribution is to incorporate that coupon payments are contingent too: their payment is conditional on the Maximum Distributable Amount not being exceeded. We examine the impact of CoCo design parameters, asset volatility and accounting noise on the price of a CoCo; and investigate the interaction between CoCo design features, the capital structure of the issuing bank and their implications for risk taking and investment incentives. Finally, we use our model to explain the crash in CoCo prices after Deutsche Bank’s profit warning in February 2016.

Keywords: Contingent Capital Pricing, Accounting Noise, Coco Triggers, Coco Design, Risk Taking Incentives, Investment Incentives

JEL Classification: G12, G13, G18, G21, G28, G32

Suggested Citation

Derksen, Mike and Spreij, Peter and van Wijnbergen, Sweder, Accounting Noise and the Pricing of Cocos (April 8, 2018). Tinbergen Institute Discussion Paper 2018-037/VI. Available at SSRN: https://ssrn.com/abstract=3162588 or http://dx.doi.org/10.2139/ssrn.3162588

Mike Derksen (Contact Author)

University of Amsterdam - Korteweg-de Vries Institute for Mathematics ( email )

Netherlands

Peter Spreij

Universiteit van Amsterdam, Korteweg-de Vries Institute for Mathematics ( email )

PO Box 94248
Amsterdam, 1090GE
Netherlands
+31 20 5256070 (Phone)

HOME PAGE: http://https://staff.fnwi.uva.nl/p.j.c.spreij/

Sweder Van Wijnbergen

Universiteit van Amsterdam ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands
+31 20 525 4011 / 4203 (Phone)
+31-35-624 91 82 (Fax)

Tinbergen Institute

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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