CoCo Bonds and Implied CET1 Volatility

27 Pages Posted: 10 Mar 2015 Last revised: 18 Dec 2015

See all articles by Jan De Spiegeleer

Jan De Spiegeleer

RiskConcile

Stephan Höcht

Independent

Ine Marquet

KU Leuven - Department of Mathematics

Wim Schoutens

KU Leuven - Department of Mathematics

Date Written: December 18, 2015

Abstract

In this work we introduce the notion of implied Core Equity Tier 1 volatility and the concept of a risk-adjusted distance to trigger. Using a derivatives-based valuation approach, we are able to derive the implied CET1 volatility from the market price of a CoCo bond in a Black-Scholes setting. The numerical results in this paper show how different contingent convertibles issued by the same bank and sharing a similar contractual CET1 trigger, have almost identical implied CET1 volatility levels. The same results confirm the difference in market risk between Tier 2 and Additional Tier 1 CoCo bonds. The ability to obtain an implied level for the CET1 volatility offers other interesting results. We are able to determine the implied CET1 level corresponding to a coupon cancellation. It further allowed us for example to look at the severity of one of the stress tests imposed by the ECB on European banks in November 2014. In that perspective we were also able to derive implied PONV CET1 levels.

Keywords: contingent convertibles, CoCo bonds, CET1, Core Equity Tier 1, PONV, Point of Non-Viability

JEL Classification: G12, G13, G18, G21, G28, G32

Suggested Citation

De Spiegeleer, Jan and Höcht, Stephan and Marquet, Ine and Schoutens, Wim, CoCo Bonds and Implied CET1 Volatility (December 18, 2015). Available at SSRN: https://ssrn.com/abstract=2575558 or http://dx.doi.org/10.2139/ssrn.2575558

Jan De Spiegeleer (Contact Author)

RiskConcile ( email )

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Stephan Höcht

Independent

Ine Marquet

KU Leuven - Department of Mathematics ( email )

Celestijnenlaan 200 B
Leuven, B-3001
Belgium

Wim Schoutens

KU Leuven - Department of Mathematics ( email )

Celestijnenlaan 200 B
Leuven, B-3001
Belgium

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