DP14530 Risk-Taking, Competition and Uncertainty: Do CoCo Bonds Increase the Risk Appetite of Banks?

Author(s): Mahmoud Fatouh, Ioana Neamtu, Sweder van Wijnbergen
Publication Date: March 2020
Keyword(s): Bank Capital Structure, Contingent Convertible Bonds, Risk Taking
JEL(s): G01, G11, G21, G32
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14530

We assess the impact of contingent convertible (CoCo) bonds and the wealth transfers they imply conditional on conversion on risk-taking behaviour of the issuing bank. We also test for regulatory arbitrage: do banks by issuing CoCos try to maintain risk taking incentives when regulators reduce them by insisting on higher capitalization ratios? While we test for and reject sample selection bias, we show that CoCo bonds issuance has a strong positive effect on risk-taking behaviour, and so do conversion parameters that reduce dilution of existing shareholders upon conversion. Higher volatility amplifies the impact of CoCos on risk taking.