Convertible Bonds and Bank Risk-Taking

Arbeitspapier

We study the effect of going-concern contingent capital on bank risk choice. The possibility of debt for equity conversion forces deleveraging in highly levered states, when risk incentives are worse. The additional equity reduces endogenous risk shifting by diluting returns in high states. An optimally designed trigger and convertible debt amount trades off this risk reduction against its debt dilution effect. Interestingly, contingent capital may be less risky in equilibrium than traditional debt, as its lower priority is compensated by reduced endogenous risk. Its effectiveness in risk reduction depends critically on the informativeness of the trigger. Adopting a noisy market trigger produces excess conversion (type II error), while an accounting trigger converts too infrequently (type I error) because of regulatory forbearance.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: Tinbergen Institute Discussion Paper ; No. 12-106/IV/DSF41

Classification and Topics

• Classification: Wirtschaft ; Contingent Pricing; Futures Pricing; option pricing ; Banks; Depository Institutions; Micro Finance Institutions; Mortgages ; Financial Institutions and Services: Government Policy and Regulation
• Subject: Risk shifting ; Financial Leverage ; Contingent Capital ; Wandelanleihe ; Spekulation ; Bankrisiko ; Bankgeschäft

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Martynova, Natalya ; Perotti, Enrico
• Event: Veröffentlichung
• (who): Tinbergen Institute
• (where): Amsterdam and Rotterdam
• (when): 2012

Further information

• Handle: http://hdl.handle.net/10419/87525
• Last update: 10.03.2025, 11:44 AM CET