Contingent capital with stock price triggers in interbank networks

Research output: Contribution to journalArticleScientificpeer-review

Abstract

This paper studies the existence and uniqueness of equilibrium prices in a model of the banking sector in which banks trade contingent convertible bonds with stock price triggers among each other. This type of financial product was proposed as an instrument for stabilizing the global banking system after the financial crisis. Yet it was recognized early on that these products may create circularity problems in the definition of stock prices—even in the absence of trade. We find that, if conversion thresholds are such that bond holders are indifferent about marginal conversions, there exists a unique equilibrium irrespective of the network structure. When thresholds are lower, the existence of equilibrium breaks down, whereas higher thresholds may lead to multiplicity of equilibria. Moreover, there are complex network effects. One bank’s conversion may trigger further conversions—or prevent them, depending on the constellations of asset values and conversion triggers.
Original languageEnglish
Pages (from-to)520-543
JournalMathematics of Operations Research
Volume48
Issue number1
DOIs
Publication statusPublished - Feb 2023

Keywords

  • contingent capital
  • contingent convertible bonc
  • interbank networks
  • financial stability
  • equilibrium
  • fixed point

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