Capital Structure Models and Contingent Convertible Securities

We implemented a methodology to calibrate capital structure models for banks that have issued contingent convertible securities (CoCos). Typical studies involving capital structure model calibration focus on non-financial firms as they have lower leverage and no contingent convertible securities. From a theoretical perspective, we found that jumps in the asset value process were necessary to obtain a satisfactory fit to the market data. In practice, contingent capital conversion triggers are discretionary, and there is considerable uncertainty around when regulators are likely to enforce conversion. The market-implied conversion triggers we obtain indicate that the market expects regulators to enforce conversion while the issuing bank is a going concern, as opposed to a gone concern. This fact is presumably of interest to potential dealers, regulators, issuers, and investors.