Abstracts

Contingent convertibles (CoCo bonds) have seen an issuance of up to \$70 bn (Dec 2013) and have attracted a lot of interest from hedge funds, institutional investors and retail investors. While the Basel III regulation is being rolled out and implemented into national law, banks are increasingly reinforcing their balance sheet with this particular asset class. In the new regulatory framework, contingent capital can either be considered as Tier 2 or as additional Tier 1 (AT1) capital. The latter category has a perpetual nature and has several embedded call dates. Contradictory to the callable hybrids bonds issued before the 2008 financial crisis, the AT1 category does not contain a coupon step up. For this particular reason, extension risk will play a more prominent role in CoCo bonds with an issuer call. This exposes the investor to negative price convexity for interest rate or credit spread changes. The valuation of extension risk for CoCo bonds has been modeled this paper.