Monetary and Economic Studies vol.36 / November 2018

The Implied Bail-in Probability in the Contingent Convertible Securities Market

Masayuki Kazato, Tetsuya Yamada

The issuance of contingent convertible securities (CoCos) has increased not only in Europe but also in Asia and other areas over the past several years. In this paper, we extend the existing model used to price CoCos to estimate the implied bail-in probability for a variety of CoCos by modifying loss rates for investors due to bail-ins of CoCos. Using our model for empirical analyses, we find that when the events that may lead to a deterioration in the soundness of the issuer banks occur, the bail-in probabilities of the CoCos increase by more than the default probabilities implied by credit default swaps (CDS). The result suggests that the bail-in probability can be used as an early warning indicator of financial crises. We also find that the conditional default probability after bail-in tends to be lower the more CoCos a bank has issued. This finding indicates that investors believe financial institutions become less likely to default as issuing more CoCos strengthens their loss absorption capacity. Overall, our analysis suggests that the market prices of CoCos contain useful information on financial stability.

Keywords: Market-implied bail-in probability; Contingent convertible securities; Basel III; Financial stability

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

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