Contagion in the CoCos Market?: A Case Study of Two Stress Events
35 Pages Posted: 22 Jun 2018
Date Written: June 8, 2018
The post crisis regulatory framework has fostered the development of the market for contingent convertible bonds (CoCos). These instruments allow for loss-absorption as a going concern but their critics warn about their potential destabilizing effects in stress situations. We analyse the dynamics of the European CoCos market during two stress episodes occurred in 2016 and triggered by news on substantial unexpected losses faced by a European systemic bank. Our econometric approach aims at disentangling the fundamental contagion channels of the distress of DB’s CoCos to the rest of the market from a CoCo-specific contagion channel. We find evidence of significant CoCo-specific contagion in the two stress episodes that could result from investors’ reassessment of CoCos’ riskiness or from uncertainty on their supervisory treatment. Moreover, we find that the CoCo-specific contagion was weaker in the second stress event, suggesting that as investors learn about the specificities of these instruments and their supervisory treatment the CoCos market becomes more resilient.
Keywords: CoCos, Basel III, Contagion
JEL Classification: G14, G21, G28
Suggested Citation: Suggested Citation