Risk-Taking, Competition and Uncertainty: Do Coco Bonds Increase the Risk Appetite of Banks?
55 Pages Posted: 8 May 2020
Date Written: March 2020
Abstract
We assess the impact of contingent convertible (CoCo) bonds and the wealth transfers they imply conditional on conversion on risk-taking behaviour of the issuing bank. We also test for regulatory arbitrage: do banks by issuing CoCos try to maintain risk taking incentives when regulators reduce them by insisting on higher capitalization ratios? While we test for and reject sample selection bias, we show that CoCo bonds issuance has a strong positive effect on risk-taking behaviour, and so do conversion parameters that reduce dilution of existing shareholders upon conversion. Higher volatility amplifies the impact of CoCos on risk taking.
Keywords: Bank Capital Structure, Contingent Convertible Bonds, Risk Taking
JEL Classification: G01, G11, G21, G32
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