Enhanced equity-credit modelling for contingent convertibles. Issue 10 (2nd October 2016)

• Record Type: Journal Article
• Authors: Chung, Tsz-Kin; Kwok, Yue-Kuen
• Is Part Of: Quantitative finance. Volume 16:Issue 10(2016)
• Page Start: 1511
• Page End: 1527
• Publication Date: 2016-10-02
• Subjects: Contingent convertibles -- Equity-credit modelling -- Fortet algorithms; Finance -- Periodicals; Business mathematics -- Periodicals; Finance -- Mathematical models -- Periodicals; Investments -- Mathematics -- Periodicals; Economics -- Periodicals; Finances -- Modèles mathématiques -- Périodiques; 332.015118
• DOI: 10.1080/14697688.2016.1171379
• Languages: English
• ISSNs: 1469-7688

Abstract

Abstract : Contingent convertible (CoCo) bonds are characterized by forced equity conversion under either an accounting or regulatory trigger. The accounting trigger occurs when the capital ratio of the issuing bank falls below some contractual threshold. Under the regulatory trigger, sometimes called the point-of-non-viability (PONV) trigger, the regulatory authority may enforce equity conversion when the financial health of the bank deteriorates to certain distressed level. In this paper, we propose an equity-credit modelling of the joint process of the stock price and the capital ratio that integrates both a structural approach for the accounting trigger and a reduced-form approach for the PONV trigger of equity conversion. We also construct effective Fortet algorithms and finite difference schemes for numerical pricing of CoCo bonds under various forms of equity conversion pay-off. The pricing properties of CoCo bonds are examined under different assumptions for the state-dependent intensity of the PONV trigger, the contractual specifications and market conditions.