Mahmoud Fatouh and Ioana Neamțu
Since 2009, contingent convertible (CoCo) bonds have become a popular instrument European banks use to partially meet their capital requirements. CoCo bonds have a loss-absorption mechanism (LAM). When LAM is triggered, the bonds convert to equity capital or have their principal written down, providing more loss-absorbing capacity while a bank is still a going concern. The existing literature argues these bonds could increase risk-taking if shareholders gain at the expense of CoCo holders when the trigger is hit. In our two papers, we assess this argument theoretically and empirically. We show that the risk-taking implications of CoCo bonds rely on the direction and the size of the wealth transfer between shareholders and CoCo holders when LAM is triggered.
