Research On The Provision Design And Pricing Of Contingent Convertible Bonds Based On The Path Dependence

Contingent convertible bonds, with powerful bail-out efficacy on capital, can play an important role in improving the absorbability of bank losses, which is helpful to reduce the government’s bailout stress and then solve the "Too Big to Fail" problem of financial institutions.As a new type of financial derivative, if contingent convertible bonds are effective promotion in the market, rational provision design and accurate pricing will be vitally important. At present, the academic field has acquired some achievements, but the provisions of contingent convertible bonds contract are lack of substantive innovation, and the consideration of how to set the basic provision element level is also insufficient. At the same time, present pricing methods always have multiple equilibrium problem, and the path-dependent characteristic of this derivative’s value is usually ignored. Consequently, for the purpose of improving the financing efficiency as well as market acceptance degree of contingent convertible bonds, and then ensuring the bonds’smooth issuing and running, this thesis has an in-depth discussion on the provision design and pricing of contingent convertible bonds. The main results are listed as follows:(1) Puts forward the improved method of pricing contingent convertible bonds under discrete and continuous time, solving existing studies’problems like multiple equilibria.Aiming at the multiple equilibria and path dependence problems of existing studies, this thesis puts forward relevant improvement measures, such as resetting the trigger, adjusting the conversion time point and describing the bond’s survival probability. Moreover, regarding common contingent convertible bonds (CoCos for short) as research object, and according to path dependence theory, this thesis firstly adopts the binomial tree model to describe the bond’s survival probability under discrete time, and values the bond. Then as expansion, this thesis builds a CoCos pricing model under continus time. In addition, taking the contingent convertible bonds "BCN" issued by Credit Suisse for example, this thesis shows detailed pricing steps and looks at the impacts of issuing bank’s asset value as well as asset volatility on the contingent convertible bonds’value via sensitivity analysis. This research achievement is of guiding significance for the bank improving the bond pricing accuracy and choosing the bond’s issuing time. (2) Designs the share-callable CoCos (SCCs), and builds a relative theoretical pricing model considering the path dependence characteristic.On the basis of CoCos, this thesis adds a share-callable provision and then forms SCCs. Firstly, by describing and analyzing the operation mechanism of SCCs, this thesis proves its major advantages for comparing with CoCos, and finds that SCCs can be transformed to the composition of a series of coupons, a zero coupon and default-free bond, and a short put option. Secondly, this thesis adopts the principle of Jarrow-Turnbull model to describe the the path dependence characteristic of the bond’s survival probability, and then provides a zero-coupon SCCs’value model at the beginning of the period, by combining common option valuation method. Thirdly, considering the interest payment issue, a more actually available SCCs pricing model is built. Finally, adding the share-callable provision to "BCN", this thesis makes relevant valuation and sensitivity analysis. This research achievement is of the theoretical guiding significance in taking account of the interests of issuers and investors simultaneously, overcoming the multiple equilibria and path dependence problems, and improving the financing efficiency of contingent convertible bonds.(3) Designs the Share-Putable&Callable CoCos (SPCCs), and builds a relative theoretical pricing model considering the path dependence characteristic.On the basis of CoCos, this thesis adds a share-putable&callable provision and then forms SPCCs. Firstly, by describing and analyzing the operation mechanism of SPCCs, on one hand, this thesis proves its major advantages for comparing with CoCos and SCCs, namely that it does not only contain a rewards and punishment system for the issuing banks, but also provides an effective stop-loss system for its invesrors, so the bond SPCCs is more beneficial to improve the market acceptance degree of contingent convertible bonds and ensure its financing efficiency; on the other hand, this thesis finds that SPCCs can be transformed to the composition of a long common contingent convertible bond, a long Down-and-in Put Barrier Option and a short Up-and-in Call Barrier Option. Secondly, this thesis also adopts the principle of Jarrow-Turnbull model to describe the the path dependence characteristic of the bond’s survival probability, derives value models of three parts contained in SPCCs, by combining barrier option methods, and then builds a detailed SPCCs pricing model through consolidation. Finally, adding the share-putable&callable provision to "BCN", this thesis makes relevant valuation and sensitivity analysis. This research achievement not only helps encourage and restrict the business practices of issuing bank after debt-to-equity swap, but also can effectively reduce the risk of investors holding bond by providing a stop-loss system, so it is of the theoretical guiding significance in better taking account of the interests of issuers and investors simultaneously, and then further improving the market acceptance degree of contingent convertible bonds. (4) Builds an optimal capital structure model of banks, considering contingent convertible bonds’trigger point difference.Contingent convertible bonds’bail-out efficacy on capital is realized mainly by timely and effectively perfecting the issuing bank’s capital structure. As a result, taking CoCos as the research object, this thesis looks at the impact of cntingent convertible bonds’key pricing parameters, which are the bond contract’s basic provision elements, on the issuing bank’s capital structure, and provides a complete analysis idea by taking trigger point as example. This thesis firstly divides the trigger point level of CoCos according to several key indicators (including indirect bankruptcy costs, direct bankruptcy costs and debt at the end of period), which can reflect capital positions; then in the logical order that creditors forecast risk and shareholders make investing&financing decisions, we build an optimal capital structure model of banks based on contingent convertible bonds with different trigger points, from which this thesis endogenously gets the optimal investment risk, optimal debt financing volume, equity value and bank value, when CoCos, substituting for direct debts, is used to finace. The results from model analysis and simulation indicate that from the angle of maximizing vaules of bank, shareholders and investors, the ideal setting range of trigger point is always between direct bankruptcy costs and debt at the end of period. At the same time, compared with direct debt, debt financing with CoCos can make the bank’s optimal investment risk higer, a debt capital in the capital structure more. This research achievement not only helps improve rationality of the provision design and pricing of contingent convertible bonds, but also provides a microscopic explanation way on the appearance of contingent convertible bonds.This thesis is of the following practical value:Firstly, by adding two kinds of additional provisions, it reflects the incentive and restriction to stakeholders of contingent convertible bonds, and contributes to the realization of incentive compatibility situation in the process of issuing and using this product. Secondly, by establishing reasonable pricing model, it can help to meet stakeholders’matching requirement of income and risk, help issuers use this bond to conduct effective risk management, and in turn help reduce external negative effects of the bank’s extreme financial risk. Thirdly, it has built up a solid foundation for further designing more efficient contingent capital, as it is hopefully to propose relative products with characteristics of controlling risk source, sharing middle risk and coordinating later risk in the future, then this thesis may help realize the state that stakeholders defense and control extremen financial risk together.