Contagion in the CoCos Market? A Case Study of Two Stress Events

42 Pages Posted: 31 Jul 2019

Multiple version iconThere are 2 versions of this paper

Date Written: November 6, 2018

Abstract

The post-crisis regulatory framework has fostered the development of the contingent convertible bonds (CoCos) market. These instruments permit banks to absorb losses as a going concern but their critics warn that they could have potentially destabilizing effects in stress situations. We analyse the dynamics of the European CoCos market during two stress episodes that occurred in 2016 and that were triggered by news of substantial unexpected losses faced by a European systemically important bank. Our econometric approach aims to disentangle the fundamental channel by which the contagion of such bank’s distress spreads to the rest of the market from a possible CoCo-specific contagion channel. We find evidence of significant CoCo-specific contagion in the two stress episodes, which could be the result of investors’ reassessment of the CoCos’ riskiness or of uncertainty about 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 specific features 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

Bologna, Pierluigi and Miglietta, Arianna and Segura, Anatoli, Contagion in the CoCos Market? A Case Study of Two Stress Events (November 6, 2018). Bank of Italy Temi di Discussione (Working Paper) No. 1201. Available at SSRN: https://ssrn.com/abstract=3429168 or http://dx.doi.org/10.2139/ssrn.3429168

Pierluigi Bologna (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Arianna Miglietta

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Anatoli Segura

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

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