Contingent Convertible ('CoCo') Bonds: A First Empirical Assessment of Selected Pricing Models

Abstract

With several banks issuing substantial amounts of contingent convertible (“coco”) bonds since 2009 this paper is the first to analyse empirically the suitability of selected pricing models that have been proposed for this kind of instrument. The analysis of coco bond issues by major banks shows that all tested approaches – a structural, an equity derivatives and a credit derivatives model – are largely able to fit observed coco bond prices. Regarding the derivation of hedge ratios, however, all models are found to exhibit biases. Overall, the results point to the equity derivatives model with its straightforward parameterisation and interpretation as the comparatively most promising approach for the practical pricing and risk management of coco bonds. Given the limited set of bonds and time series available for the analysis, more empirical research into the still young market is required.

Keywords: Contingent Capital, Convertible Bonds, Pricing, Solvency, Banking Regulation

JEL Classification: G13, G18