Network Valuation under Equity Conversions

Abstract

We build on the literature on financial contagion using models of cross-holdings of equity participations and debt in different seniority classes, and extend them to include bail-ins and contingent convertible debt instruments, two mechanisms of debt-to-equity conversion. We combine these with recently proposed methods of network valuation under stochastic external assets, allowing for the pricing of debt instruments in each seniority layer and the calculation of default probabilities. We show that there exist well-defined valuations for all financial assets cross-held within the system. We provide Matlab implementations of all the algorithms.

Keywords: asset pricing, contingent convertible securities, financial regulation, systemic risk