Addressing Systemic Risk Using Contingent Convertible Debt — A Network Analysis

Gupta, Aparna; Lu, Yueliang; Wang, Runzu

doi:10.2139/ssrn.3314658

Cited by 7 publications

(5 citation statements)

References 32 publications

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“…Both theoretical and empirical points of view were adopted and led to original operational research methodologies (e.g. Calabrese and Osmetti, 2019;Gupta et al, 2021). Indeed, the overall knowledge of the level of systemic risk associated with each single company or financial instrument reveals several advantages.…”

Section: Introductionmentioning

confidence: 99%

Dynamic large financial networks via conditional expected shortfalls

Bonaccolto

Caporin

Maillet

2022

European Journal of Operational Research

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In this article, we first generalize the Conditional Auto-Regressive Expected Shortfall (CARES) model by introducing the loss exceedances of all (other) listed companies in the Expected Shortfall related to each firm, thus proposing the CARES-X model (where the 'X', as usual, stands for eXtended in the case of large-dimensional problems). Second, we construct a regularized network of US financial companies by introducing the Least Absolute Shrinkage and Selection Operator in the estimation step. Third, we also propose a calibration approach for uncovering the relevant edges between the network nodes, finding that the estimated network structure dynamically evolves through different market risk regimes. We ultimately show that knowledge of the extreme risk network links provides useful information, since the intensity of these links has strong implications on portfolio risk. Indeed, it allows us to design effective risk management mitigation allocation strategies.

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Section: Introductionmentioning

confidence: 99%

Dynamic large financial networks via conditional expected shortfalls

Bonaccolto

Caporin

Maillet

2022

European Journal of Operational Research

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“…Of these recent contributions, Feinstein and Hurd (2020) is closest in spirit to our paper, proving existence of equilibrium in a model with accountingbased triggers but allowing, e.g., for CoCos with different maturities. Gupta et al (2020) show both in simulations and empirically that CoCos are an effective instrument for mitigating systemic risk. Beyond simple accounting-based triggers, they also consider extensions where conversion mechanisms take into account the balance sheets of the entire banking system.…”

Section: Related Literaturementioning

confidence: 94%

Contingent Capital with Stock Price Triggers in Interbank Networks

Balter¹,

Schweizer²,

Vera³

2020

Preprint

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This paper studies existence and uniqueness of equilibrium prices in a model of the banking sector in which banks trade contingent convertible bonds with stock price triggers among each other. This type of financial product was proposed as an instrument for stabilizing the global banking system after the financial crisis. Yet it was recognized early on that these products may create circularity problems in the definition of stock prices -even in the absence of trade. We find that if conversion thresholds are such that bond holders are indifferent about marginal conversions, there exists a unique equilibrium irrespective of the network structure. When thresholds are lower, existence of equilibrium breaks down while higher thresholds may lead to multiplicity of equilibria. Moreover, there are complex network effects. One bank's conversion may trigger further conversions -or prevent them, depending on the constellations of asset values and conversion triggers.

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“…We refer to Glasserman and Nouri (2012); Avdjiev et al (2013); Spiegeleer et al (2018) for detailed discussion of specific kinds of convertible bonds and methodologies for pricing these obligations in a single institution setting. Gupta et al (2019) presents a case study of the use of contingent convertible debts for reducing systemic risk when all such obligations are due outside the financial system. The present model of networks with contingent convertible obligations is, fundamentally, a variation of the network clearing model first proposed by Eisenberg and Noe (2001) that accounts for bankruptcy costs as proposed in Rogers and Veraart (2013), and equity crossholdings between financial institutions as modeled in Suzuki (2002); Gouriéroux et al (2012).…”

Section: Introductionmentioning

confidence: 99%

Contingent Convertible Obligations and Financial Stability

Feinstein¹,

Hurd²

2020

Preprint

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This paper investigates whether a financial system can be made more stable if financial institutions share risk by exchanging contingent convertible (CoCo) debt obligations. The question is framed in a financial network model of debt and equity interlinkages with the addition of a variant of the CoCo that converts continuously when a bank's equity-debt ratio drops to a trigger level. The main theoretical result is a complete characterization of the clearing problem for the interbank debt and equity at the maturity of the obligations. We then consider a simple setting in which introducing contingent convertible bonds improves financial stability, as well as specific networks for which contingent convertible bonds do not provide uniformly improved system performance. To return to the main question, we examine the EU financial network at the time of the 2011 EBA stress test to do comparative statics to study the implications of CoCo debt on financial stability. It is found that by replacing all unsecured interbank debt by standardized CoCo interbank debt securities, systemic risk in the EU will decrease and bank shareholder value will increase.

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Addressing Systemic Risk Using Contingent Convertible Debt — A Network Analysis

Cited by 7 publications

References 32 publications

Dynamic large financial networks via conditional expected shortfalls

Dynamic large financial networks via conditional expected shortfalls

Contingent Capital with Stock Price Triggers in Interbank Networks

Contingent Convertible Obligations and Financial Stability

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