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Erschienen in: Journal of Financial Services Research 1/2018

31.08.2016

Bank Contingent Capital: Valuation and the Role of Market Discipline

verfasst von: Chia-Chien Chang, Min-Teh Yu

Erschienen in: Journal of Financial Services Research | Ausgabe 1/2018

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Abstract

This paper develops a structural model to evaluate contingent capital notes (CCN) of Basel III under alternative regulatory closure rules. Our dynamic model has a fixed default barrier and at specific discrete time points an additional higher default barrier depending on the closure threshold. The closed-form expressions of CCN and subordinated debts (SD) in the simple Merton model are presented to understand the convex relationship between the price and capital ratio trigger of CCN and to examine the effects of closure rules on CCN and SD through their derivatives’ properties. Our numerical results in the more general model show that a lax closure rule increases the price of SD and distorts the risk information of issuing banks, but not so for CCN. The policy implications are that CCN are more effective than SD in terms of enhancing market discipline because the price/yield information of CCN is more sensitive to the issuing bank’s risk than SD and will not be distorted by regulatory closure rules.

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Fußnoten
1
See data reported in the Basel Committee on Banking Supervision (2003); Flannery (2009); Pennacchi (2011).
 
2
This study updates the list collected in Buergi (2012).
 
3
Some studies (e.g., Albul et al. (2010) and Chen et al. (2015)) also use the structural approach to consider the capital structure decision and endogenous default by shareholders. This contrasts with the reduced-form approach, such as McDonald (2013) who modeled the default/recovery probability directly as an exogenous process in valuing risky debt.
 
4
The time interval can be a day, a month, a quarter, or a year, depending on how often regulators update their information of a bank’s capital ratio.
 
5
Some studies, such as Albul et al. (2010) and Chen et al. (2015), consider the case that banks use a rolling debt-structure, in which old debt is retired and new debt is issued. However, for simplicity we follow most papers, e.g. Sundaresan and Wang (2010); Pennacchi (2011), and Himmelberg and Tsyplakov (2012), by considering only a fixed finite maturity bond and firms not issuing new debt.
 
6
In some empirical specifications, CCN holders either receive a fixed number of shares or shares with a fixed value.
 
7
See Kane and Yu (1995) for evidence in the U.S. S&L industry.
 
8
See Sironi (2003) and Goyal (2005) for evidence of the correlation between bank risks and SD yields, and Hanweck and Spellman (2003) and Kane (2007) for evidence against a consistent relation between yield spreads of SD and changes in bank risk.
 
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Metadaten
Titel
Bank Contingent Capital: Valuation and the Role of Market Discipline
verfasst von
Chia-Chien Chang
Min-Teh Yu
Publikationsdatum
31.08.2016
Verlag
Springer US
Erschienen in
Journal of Financial Services Research / Ausgabe 1/2018
Print ISSN: 0920-8550
Elektronische ISSN: 1573-0735
DOI
https://doi.org/10.1007/s10693-016-0259-9