Working Paper: CEPR ID: DP14530
Authors: Sweder van Wijnbergen; Mahmoud Fatouh; Ioana Neamtu
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: contingent convertible bonds; risk taking; bank capital structure
JEL Codes: G01; G11; G21; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| issuance of coco bonds (G33) | risk-taking behavior of issuing banks (G21) |
| higher volatility (G17) | positive impact of coco bonds on risk-taking (F65) |
| expected wealth transfer from coco bond holders to existing shareholders (G34) | increased asset risk (G32) |
| presence of coco bonds on a bank's balance sheet (F65) | increases asset risk (G32) |
| presence of coco bonds (G33) | no significant effect on accounting-based measures of risk (z-score) (G32) |
| structural design of coco bonds (G33) | shaping banks' risk-taking behaviors (G21) |