Journal of Financial Stability Vol. 9 No. 2 2013
Contingent capital with a dual price trigger
Abstract
This paper evaluates a form of contingent capital for financial institutions that converts from debt to equity if two conditions are met: the firm's stock price is at or below a trigger value and the value of a financial institutions index is also at or below a trigger value. This structure potentially protects financial firms during a crisis, when all are performing badly, but during normal times permits a bank performing badly to go bankrupt. I discuss a number of issues associated with the design of a contingent capital claim, including susceptibility to manipulation, whether conversion should be for a fixed dollar amount of shares or a fixed number of shares; uniqueness of the share price when contingent capital is outstanding; the susceptibility of different contingent capital schemes to different kinds of errors (under and over-capitalization); and the losses likely to be incurred by shareholders upon the imposition of a requirement for contingent capital. I also present an illustrative pricing example.
- DOI
- 10.1016/j.jfs.2011.11.001
- Volume
- 9
- Issue
- 2
- Pages
- 230-241
- Language
- en
- Sources
- bibtex:phds-export.bib openalex crossref