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Contribution Details
| Type | Master's Thesis |
| Scope | Discipline-based scholarship |
| Title | A Framework to Discuss the Impact of Conditional Contingent Capital on Banks |
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| Institution | University of Zurich |
| Faculty | Faculty of Economics, Business Administration and Information Technology |
| Date | 2011 |
| Abstract Text | This thesis develops a simple framework to price Conditional Contingent Capital (CoCos) building on Merton's option based credit risk model. The novelty of the approach lies in the replication of the payout of contingent capital by standard financial instruments in the context of a structural model. Barrier options are an indispensable mean to reflect the conditional conversion feature of contingent capital. The fair coupon of contingent capital varies with the specific structure of the instrument. The framework is applied to illustrate the impact of CoCos on other capital tranches and to examine asset substitution and underinvestment. This thesis finds that certain CoCos variants can lead to a severe debt overhang that threatens the ability of a bank to issue new capital by traditional means. Conjectures that the conversion of contingent capital can induce a selling wave in the firm's shares are substantiated. |
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