Contingent capital with a dual price trigger

Robert L. McDonald*

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

54 Scopus citations

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.

Original languageEnglish (US)
Pages (from-to)230-241
Number of pages12
JournalJournal of Financial Stability
Volume9
Issue number2
DOIs
StatePublished - Jun 1 2013

Keywords

  • Bank capital
  • Bank regulation
  • Contingent capital

ASJC Scopus subject areas

  • Finance
  • Economics, Econometrics and Finance(all)

Fingerprint Dive into the research topics of 'Contingent capital with a dual price trigger'. Together they form a unique fingerprint.

Cite this