Economic Brief

February 2012, No. 12-02

Experimenting with Contingent Capital Triggers

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Contingent capital is debt that converts to equity when some triggering event occurs. It can automatically recapitalize a bank in distress, thus avoiding potentially costly failure. Unfortunately, little is known empirically about contingent capital regimes because there have been only a few issuances of contingent capital. Results from laboratory experiments suggest that contingent capital with price triggers would increase volatility of prices and the chance of mistakes in conversion decisions.

Additional Resources

Birchler, Urs W., and Matteo Facchinetti, "Self-Destroying Prophecies? The Endogeneity Pitfall in Using Market Signals as Triggers for Prompt Corrective Action," March 2, 2007.

Bond, Philip, Itay Goldstein, and Edward Simpson Prescott, Review of Financial Studies, February 2010, vol. 23, no. 2, pp. 781-820. (A working paper version is available online.)

Calomiris, Charles W., and Richard J. Herring, "Why and How to Design a Contingent Convertible Debt Requirement," Financial Institutions Center Working Paper No. 11-41, University of Pennsylvania Wharton School, November 2011.

Davis, Douglas, Oleg Korenok, and Edward Simpson Prescott, "An Experimental Analysis of Contingent Capital Triggering Mechanisms," Federal Reserve Bank of Richmond Working Paper No. 11-01R, Revised October 2011.

Ennis, Huberto M., and David A. Price, "Basel III and the Continuing Evolution of Bank Capital Regulation," Federal Reserve Bank of Richmond Economic Brief, no. 11-06, June 2011.

Flannery, Mark J., "Stabilizing Large Financial Institutions with Contingent Capital Certificates," Centre for Applied Research in Finance Working Paper No. 04/10, Università Bocconi, April 2010. (Free registration required to view paper.)

Prescott, Edward Simpson, "Contingent Capital: The Trigger Problem," Federal Reserve Bank of Richmond Working Paper No. 11-07, November 2011.

Price, David A., and John R. Walter, "Identifying Systemically Important Financial Institutions," Federal Reserve Bank of Richmond Economic Brief, no. 11-04, April 2011.

Sundaresan, Suresh, and Zhenyu Wang, "On the Design of Contingent Capital with Market Trigger," Federal Reserve Bank of New York Staff Report No. 448, Revised November 2011.