Contingent Capital Pricing Model and Default Probability in the Banking Industry

17 Pages Posted: 13 Nov 2018 Last revised: 10 Dec 2018

See all articles by Fathi Abid

Fathi Abid

University of Sfax, Faculty of Economic and Management Sciences, Probability & Statistics Laboratory

Ons Triki

University of Sfax - Faculty of Economic and Management Sciences - Laboratory of Probability and Statistics

Asma Khadimallah

University of Sfax - Faculty of Economic and Management Sciences - Laboratory of Probablility and Statistics

Date Written: October 22, 2018

Abstract

This paper is based on the study of Hilscher and Raviv (2014) and Tan and Yang (2015) to investigate the effects of contingent capital, a debt instrument that automatically converts into equity if the value of the asset is below a predetermined threshold on the pricing process of a bank assets’. A traceable form of the contingent convertible bond is analyzed to find a closed-form solution for the price of this bond using barrier and growth options. We represent its characteristics and examine the interaction between growth options and financing policy in a dynamic business model. We study how the contingent capital can be an effective tool for elaborating investment program, capital structure mix and stabilizing financial institutions. The potential benefits from contingent capital as financing and risk management instrument can be assessed through their contribution to reducing the probability of default associated to the subordinated debt. The appropriate choice of contingent capital parameters, the rate, and the conversion threshold can reduce shareholders incentives to change risk.

Keywords: Contingent capital, Capital structure, Default probability, Real option, Risk incentive

JEL Classification: G13, G21, G28, E58

Suggested Citation

Abid, Fathi and Triki, Ons and Khadimallah, Asma, Contingent Capital Pricing Model and Default Probability in the Banking Industry (October 22, 2018). Available at SSRN: https://ssrn.com/abstract=3270802 or http://dx.doi.org/10.2139/ssrn.3270802

Fathi Abid

University of Sfax, Faculty of Economic and Management Sciences, Probability & Statistics Laboratory ( email )

Road of Airport, Km 4
Sfax, sfax 3018
Tunisia
+216 7427 9154 (Phone)

Ons Triki

University of Sfax - Faculty of Economic and Management Sciences - Laboratory of Probability and Statistics ( email )

Asma Khadimallah (Contact Author)

University of Sfax - Faculty of Economic and Management Sciences - Laboratory of Probablility and Statistics ( email )

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