Pricing Sovereign Contingent Convertible Debt

International journal of theoretical and applied finance, Vol. 1, no. 7, 2018

32 Pages Posted: 25 Jul 2016 Last revised: 12 Jul 2021

See all articles by Andrea Consiglio

Andrea Consiglio

University of Palermo - d/SEAS

Michele Tumminello

University of Palermo; Carnegie Mellon University - Department of Social and Decision Sciences

Stavros A. Zenios

Durham University Business School; University of Cyprus; Cyprus Academy of Sciences, Letters, and Arts; Bruegel

Date Written: November 1, 2017

Abstract

We develop a pricing model for sovereign contingent convertible bonds (S-CoCo) with payment standstills triggered by a sovereign's credit default swap CDS spread. One innovation is the modeling of CDS spread regime switching which is prevalent during crises. Regime switching is modeled as a hidden Markov process and is integrated with a stochastic process of spread levels to obtain S-CoCo prices through simulation. The paper goes a step further and uses the pricing model in a Longstaff-Schwartz. American option pricing framework to compute state contingent S-CoCo prices at some risk horizon, thus facilitating risk management. Dual trigger pricing is also discussed using the idiosyncratic CDS spread for the sovereign debt together with a broad market index. Extensive numerical results are reported using S-CoCo designs for Greece, Italy and Germany with both the pricing and contingent pricing models.

Keywords: contingent bonds, sovereign debt, debt restructuring, state-contingent pricing, regime switching, credit default swaps

JEL Classification: C61, C63, D61,E3, E47, E62, F34, G21, G38, H63

Suggested Citation

Consiglio, Andrea and Tumminello, Michele and Zenios, Stavros A., Pricing Sovereign Contingent Convertible Debt (November 1, 2017). International journal of theoretical and applied finance, Vol. 1, no. 7, 2018, Available at SSRN: https://ssrn.com/abstract=2813427 or http://dx.doi.org/10.2139/ssrn.2813427

Andrea Consiglio

University of Palermo - d/SEAS ( email )

Viale delle Scienze, edificio 13
Palermo, 90124
Italy

HOME PAGE: http://portale.unipa.it/persone/docenti/c/andrea.consiglio

Michele Tumminello

University of Palermo ( email )

Viale delle Scienza
Palermo, Palermo 90128
Italy

Carnegie Mellon University - Department of Social and Decision Sciences ( email )

Pittsburgh, PA 15213-3890
United States

Stavros A. Zenios (Contact Author)

Durham University Business School ( email )

Mill Hill Lane
Durham, DH1 3LB
United Kingdom

University of Cyprus ( email )

75 Kallipoleos Street
P.O. Box 20537
Nicosia CY-1678
Cyprus
+357 2 893605 (Phone)

HOME PAGE: http://https://www.researchgate.net/profile/Stavros_Zenios

Cyprus Academy of Sciences, Letters, and Arts ( email )

Nicosia
Cyprus

Bruegel ( email )

Rue de la Charité 33
B-1210 Brussels Belgium, 1210
Belgium

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