DP17062 Risk-Taking, Competition and Uncertainty: Do Contingent Convertible (CoCo) Bonds Increase the Risk Appetite of Banks?

Author(s): Mahmoud Fatou, Ioana Neamtu, Sweder van Wijnbergen
Publication Date: February 2022
Keyword(s): Bank Capital Structure, Contingent Convertible Bonds, risk-taking, Selection Bias
JEL(s): G01, G11, G21, G32
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=17062

We assess the impact of contingent convertible (CoCo) bonds and the wealth transfers they imply conditional on conversion on the risk-taking behaviour of the issuing bank. We also test for regulatory arbitrage: do banks by issuing CoCo bonds try to maintain risk-taking incentives when regulators reduce them through 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 CoCo bonds on risk-taking.