Are CoCo Bonds a Good Substitute for Equity? Evidence from European Banks

43 Pages Posted: 26 Oct 2018

See all articles by Harald Hau

Harald Hau

University of Geneva - Geneva Finance Research Institute (GFRI); Swiss Finance Institute; Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute)

Gabriela Hrasko

University of Geneva; Swiss Finance Institute

Date Written: October 16, 2018

Abstract

Following the 2008-9 financial crisis, large banks increasingly issued contingent convertible bonds (CoCo bonds) to increase their capital buffers – a policy supported by national bank regulators. This paper examines whether the issuance of CoCo bonds provides the same reduction in bank default risk as the corresponding issuance of common equity by analyzing the premium reduction in (single name) credit default swaps (CDS) around the corresponding issuance announcement events. We find that the default risk reduction associated with issuance crucially depends on the CoCo bond’s design features: Only CoCo bond designs with permanent write-down features provide a default risk reduction similar to equity. CoCo bonds with equity conversion features come with a lower subsequent volatility of the bank asset value, but are inferior to equity in terms of their default risk reduction.

Keywords: CoCo bond, issuance announcement, asset volatility, bank stability

JEL Classification: G21, G13, G28, G32

Suggested Citation

Hau, Harald and Hrasko, Gabriela, Are CoCo Bonds a Good Substitute for Equity? Evidence from European Banks (October 16, 2018). Swiss Finance Institute Research Paper No. 18-67. Available at SSRN: https://ssrn.com/abstract=3270815 or http://dx.doi.org/10.2139/ssrn.3270815

Harald Hau (Contact Author)

University of Geneva - Geneva Finance Research Institute (GFRI) ( email )

40 Boulevard du Pont d'Arve
Geneva 4, 1211
Switzerland

Swiss Finance Institute

Switzerland

Centre for Economic Policy Research (CEPR)

London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Gabriela Hrasko

University of Geneva ( email )

102 Bd Carl-Vogt
Genève, CH - 1205
Switzerland

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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