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    Indifference curve analysis of banks' risk-taking and CoCo Covenants

    Hori, Kenjiro and Martin Cerón, Jorge (2017) Indifference curve analysis of banks' risk-taking and CoCo Covenants. Working Paper. Birkbeck, University of London, London, UK. (Unpublished)

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    Abstract

    This paper investigates two repercussions of the contingent convertible (CoCo) bond bail-in framework: the agency costs and the resulting monitoring costs. For the first, the equityholders' behaviour is analysed as a trade-off between the value of the bank and the risk taken by using an indifference curve model. While the first-best optimal risk maximises the value of the bank, the equityholders select sub-optimally high risk level under bail-in structures. This leads to both wealth transfer and value destruction agency costs. For the second, the increased required rate of return by bondholders that reflects the cost of monitoring is shown to act as a "Pigouvian tax" on the equityholders' behaviour. Utilising this, we propose different types of covenants within CoCo bonds indenture as a solution to the sub-optimal risk-taking behaviour.

    Metadata

    Item Type: Monograph (Working Paper)
    School: School of Business, Economics & Informatics > Economics, Mathematics and Statistics
    Depositing User: Ken Hori
    Date Deposited: 06 Dec 2018 15:14
    Last Modified: 21 Jul 2020 20:04
    URI: https://eprints.bbk.ac.uk/id/eprint/25372

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