3. The Contingent Convertibles Pricing Models: CoCos Credit Spread Analysis

The Additional Tier 1 contingent convertibles (AT1 CoCos) credit spread calculation is a challenging task considering numerous clauses embedded in this security. Apart from risk of trigger event occurrence, holders of AT1 CoCos are exposed to risks of coupon cancellation and call extension. The CoCos complexity is amplified by the fact that the triggering may be caused not only by the occurrence of contractually determined trigger events, but also by the behaviour of the supervision or resolution authority. In this chapter, the CoCo pricing models have been classified into market and structural models. The most prominent among the market models are credit derivatives and equity derivatives model. This chapter presents these models together with the implied CET1 volatility model in a more detailed manner as an example of structural approach. Final sections present our empirical analysis using a dozen of regressors for explaining ‘spread to Tier 2’ observable values.