Financial innovations and macroeconomic stability: an assessment of contingent convertible bonds

In the period prior to 2008, balance sheets increased so rapidly that the banking sector lent to households that could not repay. This resulted in a financial crisis that then spread to the real sector via other balance sheet effects (a drop in the net worth of the household sector and therefore in its consumption, a sharp contraction in credit etc.). To prevent this from happening again, regulators are demanding that banks be able to deal with this type of problem ex ante by setting aside larger and higher quality capital and by relying more on bail-in mechanisms. As a result, the banking sector has created a new type of asset: contingent convertible bonds (CoCos). When the banks’ ratio of assets and liabilities exceed a certain threshold, these bonds either convert into shares, which then boosts the capitalization of the bank, or are written off. These contingent convertible bonds are intended to strengthen the stability of the banking system and to ensure that the government is not required to fully assume the bailout of banks in the event of a new financial crisis.<br /><br /> As no CoCo bond has yet been activated, their effectiveness remains hypothetical. The main question in this thesis is whether or not they could fulfil their mission of stabilising the banking sector. What other effects can be expected? Given that CoCos holders might endure a total write-down of what they were supposed to earn what kind of behaviour can be expected in the event of an activation? How does this risk shifting translate for the whole economy versus a system without coco bonds? Could the costs of such bail-ins outweigh their benefits in some situations? Will CoCos play a stabilizing or destabilizing role in the event of another financial crisis? <br /><br /> This thesis aims at incorporating in a stock-flow consistent agent-based model (more precisely the JMAB model developed by Caiani et al. (2016)) the contingent convertible bonds issued by the banking sector since the 2008 crisis, allowing them to build up capital buffers that can be mobilized in the context of bail-ins when their balance sheet deteriorates too strongly. Since these bonds have never been triggered on a large scale, I propose a counterfactual analysis of what would happen in case of activation, based on an SFC-AB model. My work consists in extending the JMAB model by adding: 1. a new class of financial assets, 2. learning behaviors on the part of investors, 3. a variable opinion component (alternating between optimism and pessimism/prudence on the part of issuing banks and investors) allowing to take into account possible financial contagion effects through information spillovers.

Level thesis:degree_level

thesis.doctoral

Grantor dc:publisher

Universität Bielefeld

Year

2022

Author dc:creator

• Kremer, Elise

Repository record source_url

https://pub.uni-bielefeld.de/record/2968630

OAI identifier oai:identifier

oai:pub.uni-bielefeld.de:2968630