Contingent Capital Bonds

Contingent capital bonds are introduced to automatically strengthen the cap- ital structure of a bank when it gets into a state of possible non-viability. Through coupon cancellation and write-downs the equity increases and capi- tal ratios are strengthened. A new pricing model for a perpetual temporary write-down and coupon cancellation contingent capital bond (CoBo) is constructed, capturing a more complete set of CoBo characteristics than assessed in existing literature. The model allows for coupon cancellation, partial write-down, discretionary write- up and perpetual maturity. The CoBo suffers a write-down when a trigger process breaches a trigger level. In addition to existing literature this research uses a double exponen- tial jump diffusion trigger process. Furthermore, parameters are estimated through calibration on call option data. Using Monte Carlo the model is able to price a CoBo without using historical data on the CoBo itself. Due to the limited availability of historical data on CoBos this model solves the problem of determining an initial value at issuance. The performance of the models is evaluated using 220 daily observations on a contingent capital bond issued by Deutsche Bank.