Sundaresan is with Columbia University, Graduate School of Business, and Wang is with Indiana University, Kelley School of Business. The authors are grateful for the comments from the seminar and conference participants in the NY Fed Workshop, BIS, ECB, Toulouse Economics Group, Columbia Business, Law, and Engineering Schools, Wisconsin (Madison), Richmond Fed, Indiana (Bloomington), Exeter, SAIF, Seattle, Drexel, Baruch, the Moody's Conference, FIRS conference, IFMR, UBC Summer Conference, and FMC2 Bank Resolution Mechanism Conference. The authors especially thank Anat Admati, Pierre Collin-Dufresne, Doug Diamond, Mark Flannery, Bev Hirtle, Ken Garbade, Paul Glasserman, Larry Glosten, Charles Goodheart, Christopher Hennessy, Ravi Jagannathan, Weiping Li, Jamie McAndrews, Bob McDonald, Stewert Myers, George Pennacchi, Ned Prescott, Adriano Rampini, Marc Saidenberg, Joao Santos, Ernst Schaumburg, Chester Spatt, Kevin Stiroh, James Vickery, Cam Harvey (editor), the anonymous associate editor, and the anonymous referees for helpful remarks. Julia Dennett and Kevin Pan provided excellent research assistance.
On the Design of Contingent Capital with a Market Trigger
This article is protected by copyright. All rights reserved
This article has been accepted for publication and undergone full peer review but has not been through the copyediting, typesetting, pagination and proofreading process which may lead to differences between this version and the Version of Record. Please cite this article as doi: 10.1111/jofi.12134.
- Accepted manuscript online: 1 MAR 2014 11:45PM EST
- Manuscript Accepted: 6 NOV 2013
- Manuscript Received: 14 SEP 2012
- Cited By
Contingent capital (CC), which aims to internalize the costs of too-big-to-fail in the capital structure of large banks, has been under intense debate by policy makers and academics. We show that CC with a market trigger, in which direct stakeholders are unable to choose optimal conversion policies, does not lead to a unique competitive equilibrium unless value transfer at conversion is not expected ex-ante. The “no value transfer” restriction precludes penalizing bank managers for taking excessive risk. Multiplicity or absence of equilibrium introduces the potential for price uncertainty, market manipulation, inefficient capital allocation, and frequent conversion errors.
This article is protected by copyright. All rights reserved.