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On the Design of Contingent Capital with a Market Trigger
Author(s) -
SUNDARESAN SURESH,
WANG ZHENYU
Publication year - 2015
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/jofi.12134
Subject(s) - microeconomics , economics , capital (architecture) , ex ante , value (mathematics) , monetary economics , capital market , capital market imperfections , business , industrial organization , finance , macroeconomics , archaeology , machine learning , history , computer science
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.