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Contingent capital: the case for COERCs

Author: Pennacchi, George ; Vermaelen, Theo ; Wolff, Christian C. P.INSEAD Area: Finance Series: Working Paper ; 2010/55/FIN Publisher: Fontainebleau : INSEAD, 2010.Language: EnglishDescription: 38 p.Type of document: INSEAD Working Paper Online Access: Click here Abstract: In this paper we propose a new security, the Call Option Enhanced Reverse Convertible (COERC). The security is a form of contingent capital, i.e. a bond that converts into equity when the market value of equity relative to debt falls below a certain trigger. The conversion price is set significantly below the trigger price and, at the same time, equity holders have the option to buy back the shares from the bondholders at the conversion price. Compared to other forms of contingent capital proposed in the literature, the COERC is less risky in a world where bank assets can experience sudden jumps. Moreover, the structure eliminates concerns about putting the company in a "death spiral" as a result of manipulation or panic. A bank that issues COERCs also has a smaller incentive to choose investments that are subject to large losses. Next title: Contingent capital: the case for COERCs (RV of 2010/55/FIN) - Pennacchi, George;Vermaelen, Theo;Wolff, - 2010 - INSEAD Working Paper
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In this paper we propose a new security, the Call Option Enhanced Reverse Convertible (COERC). The security is a form of contingent capital, i.e. a bond that converts into equity when the market value of equity relative to debt falls below a certain trigger. The conversion price is set significantly below the trigger price and, at the same time, equity holders have the option to buy back the shares from the bondholders at the conversion price. Compared to other forms of contingent capital proposed in the literature, the COERC is less risky in a world where bank assets can experience sudden jumps. Moreover, the structure eliminates concerns about putting the company in a "death spiral" as a result of manipulation or panic. A bank that issues COERCs also has a smaller incentive to choose investments that are subject to large losses.

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