CoCo Bonds and Risk: The Market View

Author: Henning Hesse (Goethe University)

Title: CoCo Bonds and Risk: The Market View

Abstract: This paper investigates the impact of CoCo bond design on their market prices. Focusing on two CoCo bond features which are associated with CoCo risk, I find that (1) investors are aware of the incentive problem created in write down CoCo bonds, and demand a yield premium for that feature. Additionally, and consistent with the theory on moral hazard, this premium is higher for banks which suffer from a larger conflict of interest in the first place. Moreover, I find that (2) investors take the threat of automatic CoCo capital triggers seriously, in the sense that they reward a larger buffer towards the trigger threshold with a higher price. These insights provide important clues towards the role of CoCo bond investors' monitoring, as well as the role of CoCo bonds in the mix of regulatory capital.